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Hedging Currency Risks with Online Forex Trading

December 7, 2010 by

No, this post isn’t about profiting from Forex by using the “hedging” (grid) strategies. Two weeks ago I’ve asked my readers about their thoughts on trading Forex without stop-loss and, while I still believe that it’s generally a very bad idea, there is at least one case when trading without a stop-loss is very important — hedging.

Forex market isn’t only a good place to make money, it’s also a perfect financial instrument to hedge your currency risks. For example, you live in Germany but earn your salary in US dollars. This situation makes your income very vulnerable to EUR/USD fluctuations — a rise from 1.2000 to 1.4000 would mean a drop in the euro-value of your income by 14.3%, while a drop from 1.2000 to 1.1000 would mean a rise by 9.1%. Your dollar savings would also be affected by the change of EUR/USD rate (unless, of course, you aren’t going to spend them in US).

Many foreign contractors, transnational businessmen and outsource workers often get themselves into situations similar to the one above. Some do nothing about that, some try to wait for some “best” rate to exchange their earnings. But there’s a better solution for all those people — Forex hedging. Actually, it’s quite easy to hedge your currency risk with any online retail Forex broker. All you have to do is to open an account, make a deposit and go long on the currency pair X/Y, where X is the currency you spend in (the euro or EUR in the above example) and Y is the currency you earn in (the dollar or USD in the above example) or go short on the currency Y/X.

So, if someone is earning dollars and spending euros, he should be long on EUR/USD. This way, if euro will rise against the greenback, the purchasing power of the usual earnings of the person will still go down, but it will be compensated by the profit from his long EUR/USD position with the Forex broker. In the opposite case, if euro will decline against the USD, the purchasing power of the earnings will rise, but there will be a loss in the Forex trading at the same moment. Of course, one shouldn’t use any stop-loss or take-profit orders in hedging.

Let’s get to a more detailed example with the resident of Japan getting their income in US dollars. Their expected monthly income is $10,000. The current USD/JPY rate is 83.00. That means that their income converted to yen is ¥830,000 at this moment. They don’t want lose if the USD/JPY rate decreases. That’s why they also open a short USD/JPY position with a size of 0.1 standard lot (1 mini-lot). 1 pip of a mini-lot position in USD/JPY is equals ¥100 exactly. So, if by the end of month (when the person receives $10,000 payment) USD/JPY drops to 82.00, they lose nothing because their 100-pip profit (or ¥10,000) fully compensates the drop in the yen-denominated payment from ¥830,000 to ¥820,000. If USD/JPY goes up to 84.00 the gain in purchasing power of $10,000 (from ¥830,000 to ¥840,000) will be zeroed by the Forex loss of 100 pips (the same ¥10,000).

Such position should be closed at the end of month to book the profit/loss and reopened immediately. The person can stop reopening only if they move out of Japan and/or stop receiving dollar payments. If the payment amount changes the position size should be adjusted proportionally.

It’s quite obvious that neither stop-loss, nor take-profit aren’t required in this hedging set-up — the aim here is not to earn money from Forex trading, but to prevent any loss from your income currency depreciation. Of course, one should always remember that this strategy protects from the loss connected with currency exchange rates but also prevents any profits connected with the same reason. This strategy can be carried out with any leverage, but the very low leverage or no leverage at all is recommended because you don’t want to get a margin call on your hedging position. As always, your Forex broker should be reliable and support prompt withdrawals for this strategy to work effectively.

If you have any questions, comments or opinions regarding the use of on-line Forex trading for currency risk hedging, please, feel free to reply in the comments below.

4 Responses to “Hedging Currency Risks with Online Forex Trading”

  1. wpadmin

    Is there any forex broker who will not drain a traders account to zero but can assure returns at least $200 each month for any trader willing to start a forex trading account with $100.


    admin Reply:

    You want a broker that would guarantee at least 200% monthly ROI for you? Are you kidding me?


  2. Tiago

    If I want to hedge the incomes of 1 or 2 years, should I open and close a position every month or should I open a position covering total amount and then close every month, a position correspondent to the monthly income?


    admin Reply:

    If you know your exact income for the next 1 or 2 years beforehand then you can close the position only in the end of the term. If you know only your income for the next month, then you’ll probably have to close the hedging position every month and reopen it according to your next monthly income.


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