Morgan Stanley's product line of international stock market indices (MSCI) is well known among professional portfolio managers. Many investment professionals use the MSCI Japan Index as the benchmark against which they measure their performance. Morgan Stanley spends a lot of time perfecting its index measurement, which has allowed MSCI to take the lead in the indexing field from the Nikkei-225 Index and the TOPIX-150 Index in Japan. MSCI is broader (includes more stocks), so it is more representative of the overall Japanese stock market.

Americans tend to focus more heavily on their own domestic markets than non-U.S. investors, who tend to spread their funds throughout the globe. However, owning foreign stocks can help you diversify your returns. EWJ's correlation to the S&P 500, for example, is only 58%. Surprisingly, it shows an even lower correlation to the Hong Kong (50%) and Korea (51%) funds. If the U.S. market falls sharply, then there is little doubt that Japanese (and Korean and Hong Kong) shares will slide as well.

There are many important things you should know about trading in EWJ. First of all, it is more expensive to trade in Japan than it is in the United States. Because of this, the fund's expense ratio is much higher than most other ETFs. This means that EWJ will tend to underperform its actual benchmark index by a greater amount than most other ETFs will. However, we are still talking about a difference of less than 1% per year.

If you're a U.S. investor and you own Japanese stocks, then do you think it is good or bad if the U.S. dollar appreciates against the yen? If you said "bad," then you are correct. Why?

Imagine you buy 100 shares of Sony stock. Make believe for a moment that Sony's stock sells for 100 yen each. That means it will cost you 10,000 yen to buy those shares (100 shares times a cost of 100 yen each equals 10,000). Now, also make believe that you can buy 100 yen for $1.00. That is the same thing as saying the dollar/yen exchange rate is 100. So, if you can buy 100 yen for a dollar, then it costs you $100 to purchase your 100 shares of Sony stock (10,000 yen divided by 100 equals $100).

Now imagine that Sony's stock jumps 10% to 110 yen per share. In this scenario, the stock will now be worth 11,000 yen. Not too bad! But wait a minute. Also consider what happens if everybody decides that the U.S. economy is going to do a lot better than the Japanese economy, and that the U.S. Treasury Secretary has indicated that he wants to see the U.S. dollar go up in value. In this example, the exchange rate might change from 100 yen/dollar to 115 yen/dollar. What type of impact will this have on your stock? Well, when you convert your Sony shares back into dollars, you'll get $1.00 for every 115 yen you've got. In other words, you will get back 11,000/115, or $95.65. That means that Sony's stock went up +10%, but in dollar terms you still lost -3.35% on your investment.

Of course, it can work the other way as well. If the dollar weakened to say, 90 yen/dollar, then in this example your shares would now be worth $122.22, a +22.22% gain.

What does all this mean to you, the investor? Well, first of all it means that if you decide to look at a chart of the Nikkei-225, you shouldn't expect it to look the exact same as a chart of EWJ. It also means that when trading or investing in EWJ, you need to analyze the fund itself, plus the Japanese stock market overall and the U.S. dollar. (As luck would have it, I do all of this for you each and every week!)

A few additional notes. You may have noticed that many of EWJ's component stocks trade on the New York Stock Exchange (NYSE). In most cases, these are shares that represent the shares traded in Japan (American Depositary Receipts). They are directly affected by exchange rates as well. You cannot get around the dollar's shifting value versus the yen.

Also, note that some of the fund's component stocks are not widely traded in the United States (Takeda Chemical is one such firm). Although it makes up a sizable portion of the fund, it is only available via the Pink Sheets in the U.S. (many brokers do not trade these illiquid stocks). The shares rarely ever trade here, and you might not be able to buy or sell odd lots either.

EWJ's underlying price movements are really based on what happens in Japan. And because the Japanese stock market closes before the U.S. market, you have the rare opportunity to enter and exit trades based on trading that has already occurred. You can do so by shifting your buy and sell points prior to the opening of the U.S. markets. If you are completely wrong, and have not entered into a trade, then you will not get blindsided here since you'll have a pretty good idea of where the fund will open. The flipside is that the real activity in EWJ essentially occurs while you are most likely fast asleep. Unless you want to trade the futures markets at night in another country, you will not be able to get into or out of a position while the real action is happening.