Forex Hedging Strategy and its Methods of Hedging Currency Trades
Index 1.
What is Hedge
2. Methods of Hedging Currency Trades for the Retail
Forex Trade
1. Spot Contracts 2. Foreign Currency Options
3. Forex Hedging Strategy
What is Hedge ď‚— A hedge is an investment that protects the finances
from a risky situation.
ď‚— Hedging is done to minimize or offset the chance that
assets will lose value.
ď‚— When a currency trader enters into a trade with the intent
of protecting an existing or anticipated position from an unwanted movement in foreign currency exchange rates, they can be said to have entered into a forex hedge.
ď‚— By utilizing a forex hedge properly, a trader that is long a
foreign currency pair it can protect themselves from downside risk; while the trader that is the short foreign currency pair, can protect against upside risk.
Methods of Hedging Currency Trades for the Retail Forex Trade
1. Spot Contracts ď‚— Spot contracts are essentially the regular type of trade
that is made by a retail forex trader.
ď‚— Because spot contracts have a very short-term delivery
date, they are not the most efficient currency hedging vehicle.
ď‚— Regular spot contracts are the reason that a hedge is
needed, rather than used as the hedge itself.
2. Foreign Currency Options ď‚— Foreign currency options are one of the most popular
methods of currency hedging.
ď‚— On other types of the securities, the foreign currency
option gives the purchaser right, but not the obligation, to buy or sell the currency pair at the appropriate exchange rate at some time in the future.
ď‚— Regular options strategies can be employed, such as
long strangles and bull or bear spreads, to limit loss potential of a trade.
Forex Hedging Strategy ď‚— A forex hedging strategy is developed in four parts,
including an analysis of the forex trader's risk tolerance, risk exposure and preference of strategy.
ď‚— These components make up the forex hedge.
1. Analyze Risk ď‚— The trader must identify what types of risk (s)he is
taking in the current or proposed position.
ď‚— From there, the trader must identify what the
implications could be of taking on the risk un-hedged, and determine the risk is high or low in the forex currency market.
2. Determine Risk Tolerance ď‚— The trader uses their risk tolerance levels, to determine
how much of the position's risk needs to be hedged.
ď‚— No trade will ever have zero risks; it is up to the trader
to determine the level of risk they are willing to take, and how they are willing to pay to remove excess risks.
3. Determine the Forex Hedging Strategy ď‚— If using foreign currency options to hedge the risk of a
currency trade, the trader must determine which strategy is the most cost-effective.
4. Monitor the Strategy ď‚— By making assured that the strategy works the way it
should, the risk will stay minimized.
ď‚— The forex currency trading market is a risky one, and
hedging is the only way that a trader help to minimize the amount of risk they take on.
ď‚— So much of being a trader is money and risk
management which have another tool like hedging in the arsenal is incredibly useful.
Thank You