Candlestick Trading Blog
August 28, 2009
Forex Hedge
| What is a forex hedge? This type of hedge occurs when a currency trader enters into a trade with the goal of protecting an existing or an expected position from a move that is unwanted in the foreign currency exchange rates. How it works is that a forex trader who is short a foreign currency pair, can protect him or herself against upside risk. On the other hand, a trader who is long a foreign currency pair can find protection against down side risk. There are primarily two ways that you can enter into a forex hedge when investing in the forex markets. You can either use foreign currency options or spot contracts. Foreign currency options one a very popular form of hedging currency because it gives the buyer the right but not the obligation to buy or sell the currency pair at a particular exchange rate at a specified time in the future. You can actually use your basic options strategies, including strangles and straddles, in order to limit losses. Spot contracts are done by retail forex traders at they are your basic forex trade. They have a very short term delivery date so many don’t prefer to use spot contracts when hedging. In fact, spot contracts are usually the reason that this hedge is needed in the first place. When putting together your forex hedging strategy there are four main components to consider. These include, analysis of the traders risk exposure, their risk tolerance, and their forex trading strategy. It is important to identify the types of risk taken with each position as well as the implications could be when taking on the risk in order to determine if the risk is too high or if it is low. Traders also need to determine their own investment risk tolerance so they know how much of a position should be hedged. They need to determine the level of risk that they are comfortable with in order prevent trading anxiety from occurring, which will negatively impact their trading success. Forex traders who practice forex trading and hedging must also determine what trading strategies they will use. They must determine which strategies are proven to be the most cost effective with the forex hedge. Part of coming up with your trading strategy includes coming up with your forex trading plan. Be sure that once you develop your trading plan that you follow it! Too often traders spend time developing their trading plan only then failing to actually follow it. Online Stock Market Reviews presented live via the internet by Stephen Bigalow |
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