International commerce has rapidly increased as the internet has provided a new and more transparent marketplace for individuals and entities alike to conduct international business and trading activities. Significant changes in the international economic and political landscape have led to uncertainty regarding the direction of foreign exchange rates. This uncertainty leads to volatility and the need for an effective vehicle to hedge foreign exchange rate risk and/or interest rate changes while, at the same time, effectively ensuring a future financial position.

Each entity and/or individual that has exposure to foreign exchange rate risk will have specific foreign exchange hedging needs and this website can not possibly cover every existing foreign exchange hedging situation. Therefore, we will cover the more common reasons that a foreign exchange hedge is placed and show you how to properly hedge foreign exchange rate risk.

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.

John Nobile – Senior Account Executive
CFOS/FX – Online Forex Spot and Options Brokerage

Are you trading at the moment? Live or demo?

Forex trading is a lot easier than some people would have us believe, but it requires discipline. If you have a workable strategy, and the discipline to only trade that strategy, you will make money, guaranteed. Where a lot of traders go wrong and lose vast amounts of money is by making trades that do not meet the criteria required by their strategy. They start to listen to other people’s ideas and follow trades, they trade on a whim when they think a currency will move a certain way, they trade data, they let losses run out of control hoping the market will turn, they take the first profit available…none of that comes within their trading strategy and they ultimately lose. It’s human nature unfortunately, we are impulsive. Retailers spend millions of dollars a year finding ways to exploit that impulsive urge in us. To be a successful trader we need to control our impulsive urges and discipline ourselves to obey our strategy without exception, we know it works, and we must stick to it in order to be successful.

With absolute discipline comes control. We will have total control over ourselves and only trade exactly what our strategy says we should trade and in a way it says we should trade it, no exceptions, none.

So now we have discipline and control we can trade our strategy without hesitation or deviation. Once our strategy has signalled a trade and even before we have entered the market we already know what the outcome will be. We will either gain, break even, or lose, there are no other choices. Our gains can be either a set amount that we decided to make each trade, or trailed with stops. Break even speaks for itself. Losses will be the amount of pips our strategy dictates we should risk. There are no unknowns, we know without any doubt what can happen because we have disciplined ourselves to trade our strategy and not deviate from it.

A classic example of losing control….you enter a trade and set a stop in your mind of 30 pips. You are confident the trade will come good, everyone said it would, even your Uncle Bedjo said it would. The price goes the wrong way by 10….15….20….25…..30 pips, it’s time to close, but instead you wait because it may come back. The price moves away further….35….40….45, oh no, this wasn’t the plan. Ok, I’ll close at what I said I would for -30 when it comes back….the price moves further….50….55….60, oh no, I cannot afford to lose that much, it is bound to come back, it has to, I’ll close at -40 when it retraces…..65…..70…..75…no way! I’m not closing now and losing all that money, no way!…..80…..85…., ok ok I’ll close for -50 when it comes, damn I knew I should have taken -50, please, ok -60 then, please?…90……95…..100, oh shit I better close, it could go anywhere…closed for -100. Shit and xxxx and xxxxx’s, that’s all this weeks gains down the crapper!

Now desperate to get back your losses you’ll trade anything that moves, roll on more losses….and more losses, and maybe the odd profit pip grabbed here and there. We’ve all been there, we’ve had reccuring nightmares about it! Discipline = control = nerves of steel. Take no prisoners, you’re in this game to make a killing not get killed. Plan the trade, and trade the plan….no exceptions. Hope that helps, and may the pips be with you

From your friend at far far away. P-lopez