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What is Hedging in Forex?

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What is Hedging in Forex?

Hedging as it applies to the forex market and trading, at its most basic form, is a strategy to protect you from losing big in a certain market position. There are many types of hedge that move from the very simple, to the more complex if you are an advanced trader, but the premise is the same. To protect your position in one currency pair by placing a trade within that same market in the opposite direction.

The Fundamentals of Hedging in Forex

The first point to note is that hedging is not always permitted by all brokers. Therefore, you should check their policy first. As mentioned, the majority of traders who engage in hedging are doing so to provide themselves with a form of protection in the event of adverse market changes. By nature, hedging is particularly common in times of market volatility when the movement is quite unpredictable.

Hedging in the forex market is also more common than in many others. This is often due to the fact that the forex market can be seen as slightly more volatile than many others that are traded. As a forex trader, there are several types of hedge that you can place to protect your position in the market.


 

Forex Hedging Strategies

While there are a range of hedging strategies available that vary in complexity, here we will outline some of the most common you can utilize depending on your broker policy and level of experience.

Simple Forex Hedging

This strategy is also known as direct hedging. It is one of the most widely used, and easy to understand hedging strategies. Direct hedging occurs when you open a position to buy (or go long) on one currency pair. You then open the same position to sell that currency pair (short).

There may be a number of reasons for doing this, but in any case, a few things happen. You now have two open positions in exactly the opposite direction. Although you do not make a profit on the actual hedge itself, it does allow you to keep your original position. This means you do not have to close your original position for a loss, and can instead start to make money through your short position. Maintaining the original position also means you could again profit if the market trend reverses.

Multiple Currency Hedging

Moving into one of the more complex hedging strategies. If you are trading in multiple currency pairs, then this strategy could be effective to a certain extent for you. Multiple currency hedging takes place when you but a long position, and a counteracting short position in one of those currencies.

For example, you may take a long position in the GBP/USD market, and a short position in the USD/JPY market. In this example, you are protected against your USD exposure to a high degree. This strategy though does not cover movements in the other currencies you are exposed to though. In these cases, if the JPY, or GBP were to fluctuate, you would still be exposed.

A variation of this strategy also sees traders take long and short positions in currency pairs that are positively correlated, meaning that if one currency pair goes down, the other will go up. Such an example of these positive correlated pairs may be the GBP/USD, and EUR/USD. So, if you hold a buying position in one, and selling position in the other, in theory, they should offset. Still though, this is not as exact a strategy as a simple direct hedge.

Forex Options Hedging

An option in forex is an agreement to exchange at a specific price in the future. It is a common instrument used by forex traders who wish to hedge their position. Again, this is referred to as something of an imperfect hedge since it can still result in some losses for you as a trader.

Using an example of how you may buy a forex option to hedge your risk, consider the following:

You have gone long on the EUR/USD at $1.08 expecting the pair to go higher. You are now concerned though that it may fall further on the release of economic data coming in the next few days. In order to mitigate this risk, you may but a put option with a strike price at something like $1.07 on the pair, and an expiration date of the option at some point beyond the data release.

If the pair then does go lower, the trader is paid out on their option based on the contract conditions set. If the news does not materialize, and the pair continues to go higher, then the trader can continue to hold their long position and will have only lost the premium set out in the option contract.

Who Hedges Forex and is it Worth It?

While only you as a trader can make the decision on whether hedging is worth it, the benefit of engaging one of the strategies mentioned here is that you do limit at least some of your exposure in the markets you are trading. Timed right, it can also put you in a more profitable position.

The question of who hedges in forex is more complex, but generally speaking, as long as the forex broker you are trading with allows hedging, then there is nothing to stop you from doing it. It is important that you understand why you are hedging and how you want the market to react but beyond that, almost all levels of trader can get involved with at least some of the strategies above.

Forex Hedging Fees and Costs

There are no direct fees related to forex hedging, but depending on your broker, you may have to pay a commission or spread on the market you are trading. This, as well as any other fees like a swap-fee if you are keeping the position open, are some other important things to factor into your calculations when determining if you should try hedging in forex.

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Anthony is a financial journalist and business advisor with several years’ experience writing for some of the most well-known sites in the Forex world. A keen trader turned industry writer, he is currently based in Shanghai with a finger on the pulse of Asia’s biggest markets.

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EUR/USD Forex Market Holds at New High Despite Continuing US Unemployment

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EUR/USD Forex Market Holds at New High Despite Continuing US Unemployment
  • Euro Holds Two Month High Against Dollar
  • European Markets Continue to Remain Optimistic
  • GBP/USD Growth Impeded by Possible Rate Change

US markets opened positively again today with the Dow Jones trading up more than 100 points to mark a sustained week of growth for markets. This has generally pushed the forex market into a more positive position as traders move away from the relative safety of the US Dollar sensing more positive times ahead. American unemployment numbers though remaining high, also point in a more positive direction.

Euro Pushing Higher Against Dollar With More Stimulus Expected

The Euro is continuing to hold its ground above the 1.10 mark as traders seem to be looking beyond more negative data coming from the US. An additional 2.1m Americans filed for unemployment last week according to the Labor Department today. This is still a huge number which would be record setting in other times. That said, forex trading seems to have been buoyed more by the 4 million drop in continuing claims. This would appear to illustrate that some Americans at least, are starting to get back to work.

With increasing hopes that the economy may be turning a corner, the EUR/USD market has emerged from a slump through the course of the week. Forex brokers note that there is much more of a risk on attitude than previously. Many hopes have also been carried by the announcement of a fresh 750 billion Euro stimulus package from the ECB. This will help the economy back on its feet as more and more countries continue their staged reopening.

US-China Relations not a Huge Concern

US-China relations appear to be continually worsening as we move toward the weekend. This comes off the back of a controversial national security law passed in Beijing which may pave the way towards less autonomy for the region. This is according to US Secretary of State Mike Pompeo at least. He has already stated his belief that Hong Kong is no longer autonomous from China. This could in turn cause difficulty in trade between the US and Hong Kong.

These comments though do not appear to have impacted markets at all. European markets continued to trade higher across the board earlier in the day. A positive sign that traders are shifting focus away from geopolitical matters and focusing solely on the economy.

Negative Rates Possibility Hurts GBP/USD

The one major forex market that has fallen back slightly today has been the GBP/USD. Sterling has failed to capitalize on weaker dollar having hit high points earlier in the week. The pound has lost about 2% on the Dollar through earlier trading in Europe.

Much of this loss seems to be stemming from the possibility that the Bank of England will impose more monetary easing measures to help stimulate the UK economy as it battles coronavirus. It is widely expected they will move toward a historic negative interest rate in the week ahead.

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GBP/USD Forex Market Among Those to Benefit From Positive Sentiment

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GBP/USD Forex Market Among Those to Benefit From Positive Sentiment
  • Pound Surges to Two-Week Highs on Reopening Hopes
  • Several UK Political Concerns Brushed Aside
  • US Markets also Jump as Optimism Prevails

The first day of trading after the Memorial Day break on Monday looks set to rejuvenate forex markets and the wider economy with a positive push. This comes amid widespread hopes of a coronavirus breakthrough, and increasing positivity that the US and global economies will be back open for business very soon. The tone has been well set by the GBP which has brushed aside political concern and controversy to reach a high point.

GBP Reawakens With Strong Positive Momentum

There had been a lot of concern surrounding the Pound and the British economy in general going into this week. The nation appeared confused by a host of unclear distancing guidelines, and has in recent days been swarmed by domestic political problems. These problems stem from a 260 mile March trip made by chief advisor to the PM, Dominic Cummings. It is alleged that he broke lockdown regulations to stay with his family as both he and his wife developed COVID-19 symptoms.

This news has caused outrage among the British public and ignited political rivalries, though it seems to have had no adverse impact on the forex market. The Pound has been buoyed by positive market sentiment which has worked to weaken the US Dollar as forex traders begin to venture outside the safe haven. At the time of writing, the pair was hitting a two-week high point about $1.23 and still moving in a positive direction.

Sterling Push is Ignoring Several Political Factors

Traders are not only ignoring the misstep of the Prime Ministers team in their surge to back Pound. They have also managed to look beyond the impending Brexit deadline of June 2nd when the transition period could be extended. Despite the apparent lack of any agreement, and the ongoing strain of the Pandemic, UK leader Johnson has repeatedly ruled out any extensions to the period.

The fact that the Bank of England remains open to imposing a negative rate to help stimulate the economy moving forward, is something else that traders seem to be ignoring. Negative rates could see people paying to save money. Implausible though it may seem, the BoE has refused to rule this out as an option. It is possible however that both of these factors have already been priced into GBP/USD trading.

US Stocks Surge With Huge Rally

The positive feeling in European markets carried over to the opening bell on Wall Street as the Dow Jones jumped 600 points and the S&P 500 index surged more than 2% to above 3000 for the first time since early March.

These positive movements were most strongly felt in companies directly impacted by the virus outbreak as hopes continue to grow that the economy will be back in full swing soon. More positive news on virus trials has further been a further boost for traders.

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GBP/USD Forex Market Among Those to Benefit From Positive Sentiment
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Forex Markets Undisturbed by US Unemployment Data

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Forex Markets Undisturbed by US Unemployment Data
  • EUR/USD Breaks Back Through Significant Barrier
  • Markets Open Lower As Unemployment Rises
  • Improving PMI also Benefits GBP Market

Millions more filed for unemployment in figures released today for the previous week ending May 16th. This news however did not appear to disrupt the forex trading market at all. Here, the EUR/USD managed to climb back through a significant level at $1.10. Sterling has also been managing to hold ground this week, likely boosted by PMI data moving in the right direction today. Markets still dipped slightly though on this morning’s opening bell.

Euro Moving Back to Stronger Position on USD Weakness

Forex brokers have noted a slight step away from the safe-haven status of the US Dollar this week. The Greenback easing up slightly throughout the week as positive drug trials and similarly supportive comments from Fed Chief Powell on the Reserve’s commitment to backing the American economy have given traders a degree of renewed hope.

This hope has translated to strengthening of the Euro as markets there continue to battle back with improving data which is albeit still at a massively low point. The preliminary PMIs for Eurozone manufacturing show an improvement to 39.5 though it is still worth noting that anything below 50 represents a contraction. The ongoing US-China tensions is one point that can drag the pair back, though traders will be hoping this geopolitical situation does not cause further turmoil.

Markets Dip Slightly but Quickly Recover

Major US markets dipped slightly on the opening bell at Wall Street. This after a week of strong rallying which accompanied a steady overall improvement in market sentiment since the beginning of the week. This early dip may well be attributed to the US unemployment claim figures for the previous week. These continue to rise, and are now at a new all-time peak of more than 38 million claims since early March.

This number includes an increase of 2.4 million on the previous week, which, although sees the number reaching a new record high, is actually a significant slowing of the pace. Still more than 25 million continuing claims are on the books. The hope is that as most states begin their staged reopening, that some of these temporary layoffs can be restored and help further boost the economy.

Sterling Also Holding Strong on Improving Data

An improving UK PMI and move away from Dollar safety has also lent some support to the Pound. PMI numbers rose to a preliminary 28.9 for April, almost double that of the previous month, yet still well inside contraction territory. This points to a slowing of the negative impacts though as the UK also slowly gets back to work amid easing lockdown restrictions.

The forex market has also undoubtedly been supported by comments from the Bank of England Governor Andrew Bailey on Wednesday. He commented that the bank were not ruling out a move to negative rates in order to stimulate economic recovery from the coronavirus pandemic.

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Forex Markets Undisturbed by US Unemployment Data
- #1 Broker in UK
- Singapore Welcome
- Australia Welcome
- 12,000 + Global Markets
- Established in 1983
- Authorized & Regulated by the FCA

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