Advantage of hedging:

Hedging can be a useful tool to the Forex trader. When you have an openposition, for example, you are long on a USD/JPY trade and you right click yourtrade on the VT platform, a menu will pop up and you have a choice to Hedgeyour trade.

If you click Hedge, you will automatically open up a position in the opposite direction at the current market price without canceling out your other position and without margin increase! In the above example you would now have a USD/JPY trade long and short. You will now neither gain or lose any equity in your account because the gains and the losses will cancel each other out.Hedge in an emergency: Hedging a losing trade won’t solve your problems, but it will:

1. Keep you from more losses 2. Give you time to think about what happened to your bad trade and 3. Give you a second chance. Some traders will hedge losing trades instead of stopping out their position, because they have a chance to win back the losses of the original bad trade.

Example: You are looking to Trade the Trend? so you go long on theEUR/USD, using the indicators in this guide. The indicators signaled BUYso you opened up a position. In case of a bad trade, you choose tohedge instead of using a stop loss (be careful when doing this). YourTrade the Trend’s indicators didn’t work and your position goes againstyou, you hedge your trade. Now you have a losing position and a winningposition going in the opposite directions. You didn’t use up any moremargin .

What do you do now?My recommendation: When your position is hedged, you are safe andyou won’t lose any more money in your account. Here is what you shoulddo:1. Wait until another chart set up occurs and proceed to step 4. or Exitthe trading platform.2.Wait till the next trading day or session3. Look for the DTF indicators the next day.4. Instead of opening up another position, simply get rid of the badposition that was hedged. So if the indicators the next day signaled long in the EUR/USD, like in the above example, then you would get rid of the short, losing hedge and hope that the price will rise enough to erase the previous days losses to make a profit.5. If your position moves against you again you can hedge that positionagain and repeat steps 1-4.Hedge a winning trade: You may also hedge a winning trade to protect yourgains, if you don’t want to completely close your position.

When you do this youwon’t gain or lose any more money with that position. The advantage to thiswould give you the opportunity to keep trading those positions in the future andgive you a break. You can always right click on your position and choose ?closewith hedge? to close both positions at once. If you hedge a winning position youcan follow the above steps 1-4 to keep trading your position the next trading day. Please note that hedging can get complicated. Try to keep it as simple aspossible and try not to have a web of hedged and un hedged positions open atthe same time as it becomes exponentially more difficult to keep track of, andwhat positions to let go etc...Hedging is also optional and you don’t need to learn how to use this tool if youchoose not to. You can be a successful trader by simply using stop and limitorders.

Disadvantage of hedging :Big disadvantage with futures is the fact that the futures market is much less liquid than the forex market. If you need to open a position whilst the futures market is closed it could be very difficult. Overnight contract do exist, but they tend to be very thinly traded which can often mean very high spreads.Another disadvantage is the execution of trades is often slower than the forex market, especially when liquidity is low. Also, leverage is much lower in the futures market. It is not uncommon for forex brokers to offer 200:1 leverage or even more. Leverage on futures contracts is much lower.Futures are used by international corporations to hedge their currency risks and also by traders seeking to profit from speculative positions.Foreign Exchange Rate Risk Exposure - Foreign exchange rate risk exposure is common to virtually all who conduct international business and/or trading. Buying and/or selling of goods or services denominated in foreign currencies can immediately expose you to foreign exchange rate risk.

If a firm price is quoted ahead of time for a contract using a foreign exchange rate that is deemed appropriate at the time the quote is given, the foreign exchange rate quote may not necessarily be appropriate at the time of the actual agreement or performance of the contract. Placing a foreign exchange hedge can help to manage this foreign exchange rate risk.
Interest Rate Risk Exposure - Interest rate exposure refers to the interest rate differential between the two countries' currencies in a foreign exchange contract.

The interest rate differential is also roughly equal to the "carry" cost paid to hedge a forward or futures contract. As a side note, arbitragers are investors that take advantage when interest rate differentials between the foreign exchange spot rate and either the forward or futures contract are either to high or too low.

In simplest terms, an arbitrager may sell when the carry cost he or she can collect is at a premium to the actual carry cost of the contract sold. Conversely, an arbitrager may buy when the carry cost he or she may pay is less than the actual carry cost of the contract bought. Either way, the arbitrager is looking to profit from a small price discrepancy due to interest rate differentials.

Foreign Investment / Stock Exposure - Foreign investing is considered by many investors as a way to either diversify an investment portfolio or seek a larger return on investment(s) in an economy believed to be growing at a faster pace than investment(s) in the respective domestic economy. Investing in foreign stocks automatically exposes the investor to foreign exchange rate risk and speculative risk. For example, an investor buys a particular amount of foreign currency (in exchange for domestic currency) in order to purchase shares of a foreign stock.

The investor is now automatically exposed to two separate risks. First, the stock price may go either up or down and the investor is exposed to the speculative stock price risk. Second, the investor is exposed to foreign exchange rate risk because the foreign exchange rate may either appreciate or depreciate from the time the investor first purchased the foreign stock and the time the investor decides to exit the position and repatriates the currency (exchanges the foreign currency back to domestic currency). Therefore, even if a speculative profit is achieved because the foreign stock price rose, the investor could actually net lose money if devaluation of the foreign currency occurred while the investor was holding the foreign stock (and the devaluation amount was greater than the speculative profit). Placing a foreign exchange hedge can help to manage this foreign exchange rate risk.

Hedging Speculative Positions - Foreign currency traders utilize foreign exchange hedging to protect open positions against adverse moves in foreign exchange rates, and placing a foreign exchange hedge can help to manage foreign exchange rate risk. Speculative positions can be hedged via a number of foreign exchange hedging vehicles that can be used either alone or in combination to create entirely new foreign exchange hedging strategies.


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Hedging and forex market

In the Forex market, hedging is a method practiced by Forex traders in order to minimize their losses. Generally, hedging involves complicated financial instrument known as derivative, and the 2 most common types of derivatives are future and options.

With these instruments used correctly, a loss in one of the investment can be offset by a gain in a derivative. In order to better understand how hedging works, let's take a car maker company in the US as an example. After the car company is US manufactures the car, they intend to sell the car in the European market. Each time when they are selling the car, they need to convert the value of the car from the USD to GBP, however, due to the constant fluctuation of the currency exchange rate, the actual value of the car (after converted to GBP) may varies. In order to protect the profit margin of the company from the fluctuation of the currency exchange, the car manufacturer company hedge and fix the conversion rate from USD to GBP at a specific value, thus eliminating the risk of losses due to fluctuation in the currency exchange. Hedging in Forex market works in a similar way mentioned above, however, there's a variety of way to hedge in the Forex market for an investor as there are numerous options and future contracts available in the Forex market.

Although hedging may sound like a foul proof technique, there are still some reasons why an investor may need to think carefully before considering to hedge in Forex market. Firstly, hedging will be a very useful tool IF an investor suffers a loss in his investment due to the fact where by hedging, the amount of losses can be decreased and minimized to a smaller amount.

However, hedging will only be a nuisance to the profit gain if the investor doesn't suffer any form of losses because the amount of potential profit would be greatly decreased due to hedging. Besides that, unlike buying insurance, hedging is not a 100% safe technique as hedging in Forex trading is not as simple as it seemed. Hedging precisely in an investment is a very complicated task and in most of the time, things may go wrong and not according to the way as planned.

For beginners in Forex trading, Forex hedging is always a very good tool to be utilized in order to avoid from suffering a huge amount of losses in their early stage of investment. Therefore, it is most advisable for all of the investors, regardless of what type of investment they are in, to understand more about hedging because this is considerably one of the most effective way in order to protect themselves in Forex trading.

How can I use Forex Hedging :Say you used dollars to take a long position in euros, but you are a little worried that the price of euros will fall relative to the dollar. One thing you could do is take out a futures contract on dollars using euros. As external factors affect the price of currencies, the price of futures contracts rise and fall as well, allowing your euros-to-dollars contract to counteract your long position in euros. If the euro weakens, the futures contract price rises, and vice-versa, so you have therefore eliminated the risk from your currency investment.

For example : try simply to buy Sell a pair of currency then do the opposite for example buy one lot of any pair and then then sell it again Now you have a hedged trade and . You can see in the "S/B" column the one position that you bought and the one that you sold. If the EUR/USD rises, you have a profit in the buy position and a loss in the sell position. If it falls, the exact opposite applies.Should I hedge?Most investors never hedge in their entire trading careers. Short-term fluctuation is something that the majority of investors do not worry with. Therefore, hedging can be pointless. Even if you choose not to hedge however, learning about the technique is a great way to understand the market a bit more.

You will see large corporations and other large traders use this and may be confused at why they are acting this way.

When you know more about hedging you can fully understand their strategies.Ways of Hedging:It's say you take a long position is EUR/USD at 1.2700. The price drops. With a different broker, you take a short position at 1.2650. Have you hedged your long?I've met traders who say yes. They say that now there short will make what every there long position loses.I hate to burst bubbles, but going long and short is going flat. It's the same as having no position on.

The only difference is you'll pay the spread twice (a bad thing).The traders who say that going long and going short is hedging say that when the price moves up they will take the short position off to capture the upward movement are still deluded.Having a short and long position in the same instrument, and then taking the short one off, is the same as just entering long. That's it. Furthermore, how do you know that the market will continue to move up after you take the short off? If it moves down again will you put the short on again? If you do, you will pay the spread a third time for a single trade. Believe, make this a habit and you find being profitable is tough even if you pick more winners than losers and have great money management.So, let's take this is a different direction.

What if you traded EUR/USD long and went short USD/CHF? Have you hedged against the dollar? No. What you've done is created the currency pair EUR/CHF with two other pairs. You're not hedged; you're long EUR/CHF.So how do you create a true hedge with currencies? You have two tools to use. One way would be with futures. The next subsection deals with the other. The CME has an emini Euro FX contract (symbol is E7).

You could be long in the spot market and short in the futures market and you would be hedged. However, the futures contract and a spot contract are not worth exactly the same; so you would not be totally covered.The last way to hedge is with options.

This is also how you can trade without stops safely. Let's say you go long USD/JPY at 116.00. You also go long a put option out of the money with a strike price at 115.50. Let's say it cost you $20.The price must go up 20 pips (in a mini account) for you break even. You lose the cost of the option if the price doesn't sink below 115.50. If the price does plunge down to 114 say, your put options will be worth a lot.

Subtracting what you made on the options from what you lost on your position, you'd find that you only lost 70 pips (the cost of the option $20 plus the difference between your entry and the strike price $50).You are truly hedged. You only lose the cost of the option if the price skyrockets (and you'll make a bundle on the price moving up so far). On the other hand, the price can sink as low as it wants to, you're loss is fixed.

This gets even better. How often has the price touched your stop taking you out of the market before going your way? With an option as a stop loss, that can't happen. You can ride out a market that wants to stop you out. Your option protects you.Obviously this is just a quick look at this strategy. If you want to do it, study the concepts behind it a lot more before you try it. Options are an animal all of their own.

Know what you are doing, before you do it.Hedging objectives :Earlier, we noted that a hedge is a financial instrument whose sensitivity to a particular financial price offsets the sensitivity of the firm's core business to that price. Straightaway, we can see that there are a number of issues that present themselvesSome of the best-articulated hedging programs in the corporate world will choose the reduction in the variability of corporate income as an appropriate target. This is consistent with the notion that an investor purchases the stock of the company in order to take advantage of their core business expertise.Other companies just believe that engaging in a forward outright transaction to hedge each of their cross-border cash flows in foreign exchange is sufficient to deem themselves hedged.

Yet, they are exposing their companies to untold potential opportunity losses. And this could impact their relative performance pejoratively.It is important to measure and to have on a daily basis some notion of the firm's potential liability from financial price risk. Financial institutions whose core business is the management and acceptance of financial price risk have whole departments devoted to the independent measurement and quantification of their exposures.

It is no less critical for a company with billions of dollars of internationally driven revenue to do so.There are three types of risk for every particular financial price to which the firm is exposed.Transactional risks reflect the pejorative impact of fluctuations in financial prices on the cash flows that come from purchases or sales. This is the kind of risk we described in our example of the pulp-and-paper company concerned about their US$10 million contract. Or, we could describe the funding problem of the company as a transactional risk. How do they borrow money? How do they hedge the value of a loan they have taken once it is on the books?Translation risks describe the changes in the value of a foreign asset due to changes in financial prices, such as the foreign exchange rate.Economic exposure refers to the impact of fluctuations in financial prices on the core business of the firm.

If developing markets economies devalue sharply while retaining their high technology manufacturing infrastructure, what effect will this have on an Ottawa-based chip manufacturer that only has sales in Canada? If it means that these countries will flood the market with cheap chips in a desperate effort to obtain hard currency, it could mean that the domestic manufacturer is in serious jeopardy.When is it best to use which instrument is the question the corporate Treasurer must answer.

The difference between a mediocre corporate Treasury and an excellent one is their ability to operate within the context of their shareholder-delineated limits and choose the optimal hedging structure for a particular exposure and economic environment. Not every structure will work well in every environment. The corporate Treasury should be able to tailor the exposure using derivatives so that it fits the preferences and the view of the senior management and the board of directors

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