Forex Hedging Strategy and its Methods of Hedging Currency Trades

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Forex Hedging Strategy and its Methods of Hedging
Currency Trades
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Index

• What is Hedge
• Methods of Hedging Currency Trades for the Retail
  Forex Trade
• 1. Spot Contracts
• 2. Foreign Currency Options
• Forex Hedging Strategy

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What is Hedge

• A hedge is an investment that protects the
  finances from a risky situation.
• Hedging is done to minimize or offset the chance
  that assets will lose value.

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• 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.
• 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.

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Methods of Hedging Currency Trades for the Retail
Forex Trade
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1. Spot Contracts

• Spot contracts are essentially the regular type
  of trade that is made by a retail forex trader.
• Because spot contracts have a very short-term
  delivery date, they are not the most efficient
  currency hedging vehicle.
• Regular spot contracts are the reason that a
  hedge is needed, rather than used as the hedge
  itself.

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2. Foreign Currency Options

• Foreign currency options are one of the most
  popular methods of currency hedging.
• 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.

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• Regular options strategies can be employed, such
  as long strangles and bull or bear spreads, to
  limit loss potential of a trade.

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Forex Hedging Strategy

• 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.
• These components make up the forex hedge.

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1. Analyze Risk

• The trader must identify what types of risk (s)he
  is taking in the current or proposed position.
• 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.

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2. Determine Risk Tolerance

• The trader uses their risk tolerance levels, to
  determine how much of the position's risk needs
  to be hedged.
• 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.

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3. Determine the Forex Hedging Strategy

• If using foreign currency options to hedge the
  risk of a currency trade, the trader must
  determine which strategy is the most
  cost-effective.

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4. Monitor the Strategy

• By making assured that the strategy works the way
  it should, the risk will stay minimized.

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• 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.
• So much of being a trader is money and risk
  management which have another tool like hedging
  in the arsenal is incredibly useful.

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Thank You