A forex hedging strategy is developed in four parts, including an analysis of the forex trader's risk exposure, risk tolerance and preference of strategy. These components make up the forex hedge:
1. Analyze risk: The trader must identify what types of risk he is taking in the current or proposed position. From there, the trader must identify what the implications could be of taking on this risk un-hedged, and determine whether the risk is high or low in the current forex currency market.
1. Analyze risk: The trader must identify what types of risk he is taking in the current or proposed position. From there, the trader must identify what the implications could be of taking on this risk un-hedged, and determine whether the risk is high or low in the current forex currency market.
2. Determine risk tolerance: In this step, the trader uses their own risk tolerance levels, to determine how much of the position's risk needs to be hedged. No trade will ever have zero risk; it is up to the trader to determine the level of risk they are willing to take, and how much they are willing to pay to remove the excess risks.
3. Determine forex hedging strategy: If using foreign currency options to hedge the risk of the currency trade, the trader must determine which strategy is the most cost effective.
4. Implement and monitor the strategy: By making sure that the strategy works the way it should, risk will stay minimized. The forex currency trading market is a risky one, and hedging is just one way that a trader can help to minimize the amount of risk they take on. So much of being a trader is money and risk management that having another tool like hedging in the arsenal is incredibly useful.
Not all retail forex brokers allow for hedging within their platforms. Be sure to research fully the broker you use before beginning to trade.
Derivatives of using a hedge position :
Futures contracts are one of the most common derivatives used to hedge risk. A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price. The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price. The ultimate goal of an investor using futures contracts to hedge is to perfectly offset their risk. In real life, however, this is often impossible and, therefore, individuals attempt to neutralize risk as much as possible instead. For example, if a commodity to be hedged is not available as a futures contract, an investor will buy a futures contract in something that closely follows the movements of that commodity.
When a company knows that it will be making a purchase in the future for a particular item, it should take a long position in a futures contract to hedge its position. For example, suppose that Company X knows that in six months it will have to buy 20,000 ounces of silver to fulfill an order. Assume the spot price for silver is $12/ounce and the six-month futures price is $11/ounce. By buying the futures contract, Company X can lock in a price of $11/ounce. This reduces the company's risk because it will be able close its futures position and buy 20,000 ounces of silver for $11/ounce in six months.
If a company knows that it will be selling a certain item, it should take a short position in a futures contract to hedge its position. For example, Company X must fulfill a contract in six months that requires it to sell 20,000 ounces of silver. Assume the spot price for silver is $12/ounce and the futures price is $11/ounce. Company X would short futures contracts on silver and close out the futures position in six months. In this case, the company has reduced its risk by ensuring that it will receive $11 for each ounce of silver it sells.
Futures contracts can be very useful in limiting the risk exposure that an investor has in a trade. The main advantage of participating in a futures contract is that it removes the uncertainty about the future price of an item. By locking in a price for which you are able to buy or sell a particular item, companies are able to eliminate the ambiguity having to do with expected expenses and profits.
Example : Hedging Against Downside Risk:Strike Cost Est. Returnreturn (19) – put Capital at Riskmarket – strike + put
125 4.2 14.8 27.01
130 5.2 13.8 23.01
135 6.3 12.7 19.11
140 7.7 11.3 15.51
In the example, buying puts at higher strike prices results in less capital at risk in the investment, but pushes the overall investment return downward.
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Not all retail forex brokers allow for hedging within their platforms. Be sure to research fully the broker you use before beginning to trade.
Derivatives of using a hedge position :
Futures contracts are one of the most common derivatives used to hedge risk. A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price. The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price. The ultimate goal of an investor using futures contracts to hedge is to perfectly offset their risk. In real life, however, this is often impossible and, therefore, individuals attempt to neutralize risk as much as possible instead. For example, if a commodity to be hedged is not available as a futures contract, an investor will buy a futures contract in something that closely follows the movements of that commodity.
When a company knows that it will be making a purchase in the future for a particular item, it should take a long position in a futures contract to hedge its position. For example, suppose that Company X knows that in six months it will have to buy 20,000 ounces of silver to fulfill an order. Assume the spot price for silver is $12/ounce and the six-month futures price is $11/ounce. By buying the futures contract, Company X can lock in a price of $11/ounce. This reduces the company's risk because it will be able close its futures position and buy 20,000 ounces of silver for $11/ounce in six months.
If a company knows that it will be selling a certain item, it should take a short position in a futures contract to hedge its position. For example, Company X must fulfill a contract in six months that requires it to sell 20,000 ounces of silver. Assume the spot price for silver is $12/ounce and the futures price is $11/ounce. Company X would short futures contracts on silver and close out the futures position in six months. In this case, the company has reduced its risk by ensuring that it will receive $11 for each ounce of silver it sells.
Futures contracts can be very useful in limiting the risk exposure that an investor has in a trade. The main advantage of participating in a futures contract is that it removes the uncertainty about the future price of an item. By locking in a price for which you are able to buy or sell a particular item, companies are able to eliminate the ambiguity having to do with expected expenses and profits.
Example : Hedging Against Downside Risk:Strike Cost Est. Returnreturn (19) – put Capital at Riskmarket – strike + put
125 4.2 14.8 27.01
130 5.2 13.8 23.01
135 6.3 12.7 19.11
140 7.7 11.3 15.51
In the example, buying puts at higher strike prices results in less capital at risk in the investment, but pushes the overall investment return downward.
About Forexgen
ForexGen.com is an online trading service provider supplying a unique and individualized service to Forex traders worldwide. We are dedicated to absolutely provide the best online trading services in the Forex market.
ForexGen provides a unique online trading experience based on our intelligent online Forex trading package, the ForexGen Trading Station, including the best online trading system.
Profile regulatory information: ForexGen is complying with all applicable international laws and all financial regulations and procedures governing its industry in order to sustain the security standards in the financial services world.
ForexGen provides a unique online trading experience based on our intelligent online Forex trading package, the ForexGen Trading Station, including the best online trading system.
Profile regulatory information: ForexGen is complying with all applicable international laws and all financial regulations and procedures governing its industry in order to sustain the security standards in the financial services world.
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