ForexGen | How do you hedge in the forex market?

Hedging is, in the simplest sense, any strategy designed to offset or reduce the risk of price fluctuations for an asset or investment. When a person or company makes an investment (like when they buy shares of a company's stock), they're betting that the price of that investments will move in a certain direction. As with any bet, there's always the risk of losing if the price moves in the opposite direction; it's this risk that investors use hedging to help offset. Creating a hedge requires the purchase of a second asset with a negative correlation to the first; this can be direct and simple (in the case of a long put to hedging against a long stock position, for example) or indirect and complex (statistical arbitrage between historically correlated pairs, for example).
A basic example of a hedge is buying a futures contract for a commodity, such as oil.

For a company that uses oil in its production process, an oil futures contract locks in a price until a given date, protecting the company from the risk that the price will rise even higher by that time. In this case, the company is said to be hedging against rising oil prices. Hedges can, however, fail; for example, if oil prices don't rise by as much as the company expected, it will still have to buy the oil at the agreed-upon price.

Hedging With Options
Options are quickly becoming the hedging instrument of choice for investors all over the world, particularly in hedging stock portfolios. This popularity is due to the versatility of returns offered by option strategies, ranging from synthetic closings, complete downside protection, complete delta-neutral hedging and multi-directional profiting. For example, a portfolio of stocks can be hedged in such a way during that movements in the stock prices do not effect overall portfolio value, rather increases in volatility leads to an increase in portfolio value. This is known as a delta neutral (vega positive) hedging.
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ForexGen | Hedging One Forex Pair with Another

While the Dollar rally may ultimately prove beneficial to US consumers (due to cheaper imports), it is certainly not helping US-based multinational corporations. Companies that earn a significant portion of their revenue abroad would normally be considered stable investments during times of economic uncertainty, since their exposure to individual economies is minimal. In the context of the current crisis, however, such companies have struggled; since they must report earnings in terms of USD, a strong Dollar is equivalent to lower earnings on foreign sales. Some companies have turned to hedging their exposure, while others have opted to either ride out the fluctuations and/or hope that they cancel each other out, banking on the notion that forex is ultimately a zero-sum game. Dow Jones reports:

To be sure, such global currency fluctuations are hard to manage and even those companies that do have hedges in place may only be able to limit and not completely offset the pressures of a strengthening greenback and oscillating exchange rates.
December 19, 2007
The hedging topic often comes up in forex forums. One recent example was a trader who likes to trade GBP/JPY in what is basically a carry strategy. In order to protect his downside, he hedges his position with a short in CHF/JPY. The two are fairly highly correlated, so that would seem to be a good hedge. In theory, it is. There’s a bit of a snag in it all, though.
Firstly, when you hedge you need to match position values. Since a lot of GBP/JPY has a higher value than CHF/JPY - remember you are buying or selling the first (base) currency - you need to actually sell more than a single lot of CHF/JPY to accomplish a full value hedge. The GBP/CHF exchange rate is currently about 2.3, meaning you would need to sell about 2.3 lots of CHF/JPY for each GBP/JPY you go long.

Here’s the catch, though. If you do that full value hedge, you actually end up creating a completely different exposure in your account. When you match a long GBP/JPY with an equal value of CHF/JPY you end up completely cancelling out your JPY exposure by going long and short equal amounts of that currency. That leaves you with a long GBP/CHF position, which obviously has completely different price action characteristics.
Of course you could then short GBP/CHF to totally nullify your risk all together. There’s not much point of that, though. In doing so you would lose your ability to gain on any type of price movement, would end up with a net loss because of the spread doing all those trades, and would probably be in a negative carry position (or at best neutral).
This is why it’s important to understand the implications to your net overall exposure when you trade multiple forex pairs, for hedging or otherwise.

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ForexGen | Forex Hedging Between Reducing Your Financial Risk And An Insurance Plan

For those who are not familiar with the Forex market, the word “hedging” could mean absolutely nothing. However, those who are regular traders know that there are many ways to use this term in trading. Most of the time when you hear this phrase it means that you are trying to reduce your risk in trading. It is something that everyone who plans to invest should know about. It is a technique that can protect your investments to some degree.

While hedging is a popular trading term, it is also one that seems a little mysterious. It is much like an insurance plan. When you hedge, you insure yourself in case a negative event may occur. This does not mean that when a negative event occurs you will come out of it completely unaffected. It only means that if you properly hedge yourself, you won’t experience a huge impact. Think of it like your auto insurance. You purchase it in case something bad happens. It does not prevent bad things from happening, but if they do, you are able to recover a lot better than if you were uninsured.

Anyone who is involved in trading can learn to hedge. From huge corporations to small individual investors, hedging is something that is widely practiced. The manner in which they do this involves using market instruments to offset the risk of any negative movement in price. The easiest way to do this is to hedge an investment with another investment. For example, the way most people would deal with this is to invest in two different things with negative correlations. This is still costly to some people; however, the protection you get from doing this is well worth the cost most of the time. When you begin about hedging, you start to understand why not many people completely know what it is all about. The techniques used to hedge are done by using derivatives. These are complicated instruments of finance and most often only used by seasoned investors.
When you decide to hedge, you must remember that it comes with a cost. You should always be sure that the benefits you get from a hedge should be more than enough to make it worth your while. You should make sure the expense is justified. If it is not, then you should not hedge. The goal of hedging is not to make money. You will not make large gains by hedging yourself. You have to take some risks in order to gain. Hedging is intended to be used to protect your losses. The loss cannot be avoided, but the hedge can offer a little comfort. However, even if nothing negative happens, you will still have to pay for the hedge. Unlike insurance, you are never compensated for your hedge. Things can go wrong with hedging and it may not always protect you as you think it will.

Keep in mind that 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.
Whether you decide to use hedging to your advantage or not, you will benefit from learning more about it. You can use it like an insurance policy when trading. You should remember however that hedging can be costly. Always check to make sure the costs of hedging will not run against any profits you may or may not make. Be sure those costs are realistic and that your need for hedging is realistic as well. You will be able to use hedging to help cut your potential losses, however hedging will never guard against the negatives altogether. Learning about it will give you a better understanding at how large traders work the system however, which can in turn make you a better player in the trading game.
Remember that hedging should be left to the Pros of the industry unless you are playing the forex market as a hobby and don't have a lot invested in it.

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ForexGen | The concept of forex hedging is simple enough

Market mavens estimate that most currency pairs move within defined ranges for approximately 80% of the time. When a breakout from such a range occurs, it tends to be sudden and sharp, the sort a trader wants to catch; however, for those who cannot sit and watch the market constantly, these can also be the moves that are easiest to miss, especially if one is asleep when the active London market opens at 8:00 AM GMT or one has misjudged the release of a particularly meaningful fundamental announcement.

It’s easy enough to set a market order at a pre-determined entry point and walk away from the computer; however, the value of that technique depends entirely upon the accuracy of one’s estimate of the market’s future direction, which of course in turn depends upon one’s proficiency in technical analysis and predicting a nation’s economic data prior to its release—not the easiest of tasks in recent months, as a well-known bank’s complete miscall of the RBNZ policy statement, released 5 June 2008, illustrates all too well.

Rather than depend upon a market forecast, no matter how carefully prepared, forex hedging traders prefer to hedge their bets and place two entry orders, one above and one below a currency pair’s trading range, and catch the market’s move whichever direction it goes.
Also, ensure that one’s broker offers the feature known as “order cancels order,” meaning that when one order is triggered, the other is automatically nullified. That way, one doesn’t have a loose trade floating about, waiting to be activated when it’s least desired, and often when one is not watching

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ForexGen | No Stop hedged Forex Grid trading system:

The no stop hedged forex grid trading system is an investment technique which creates favorable dollar cost averaging on all transactions entered into. For this reason the technique is too much of a paradigm shift for most conventional traders who like charts, support and resistance and indicators.
It is forex hedging , it is not a trading technique. It has however become very popular as a trading technique because of the short term gains that can be made. The No Stop system trades without stops. No stop loss orders are used at all except for when a group of transactions have a positive result and we want to liquidate the entire group of transactions at a net gain. Because the No Stop system cashes in its transactions regularly it becomes a trend following No Stop system too. There is no need for charts when using this No Stop system as we use predetermined price levels to cash in transactions positively (The No Stop system loves price spikes).

Transactions can or should be slow at a rate of about 3 to 4 a week. As price levels are determined well in advance orders can be placed well in advance so the No Stop system takes very little supervision. The technique is highly systematic and can easy be converted into an automatic trading system or expert adviser very easily.
The No Stop system is always in a sell and a buy at the same time and therefore can cash in on any move the market makes. Being in a sell and a buy at the same time also created a hedge. Predetermined cash in levels create a grid of price levels there positive transactions will be cashed in continuously until the group of transactions are profitable.

In simple terms you will enter the market at a particular level with an active bay and a sell. You would have predetermined levels at which you would cash in positive transactions. For instance one could decide to cash in on every 100pip (grid gap) move made in the market. When the price moves 100 pips you would cash in your positive transaction and then enter into another buy and sell transaction at that point. This process will continue until the total for the group of transaction is positive and then you would liquidate. You would then start again – as simple as that. No need for charts. Patience is the biggest virtue required.

Money is made when the price revisits some of the cash in levels over and over and over again (which it does).
In the above example should the price return to the starting level (after moving 100 pips) the group of 4 transactions in total will be positive and you would then cash in the unwanted transactions, bank your profits and start again.
The big danger of this No Stop system is strong trends with no or very few retracements. You will lose money in trends. There are however specific techniques to manage and contain these losses.
The biggest one is to start with a big grid gap. What is a trend on a 5 minute chart could be a small spike on a daily or weekly chart. Grid gaps of between 150 pips and 300 pips have been found to work well.
One could also vary the grid sizes relative to the trend to reduce the number of unhedged transaction. For example have grid gaps of 100, 200, 300 etc.
The other way is to vary the number of lots used when entering into the buy and sell transactions at a particular cash in point to ensure balanced hedging.

Trends tend to scare people away from this technique but if one views this as an investment technique and not a trading technique the trends could have a reduced impact on the annual return on investment. The market only trends 20% of the time any way. Talking about return on investment some current trading groups are showing returns of between 200% p.a. and 1000% p.a. on current investment levels. There are many trading records are available to back this up. The longer you trade this No Stop system the lower your risk and the better your return. That said, you can lose more than just your boots (your whole trading account) if you treat this No Stop system with disrespect.
Success factors for this No Stop system are: - Selecting appropriate grid sizes, currency pairs, lot sizes, cash in times and an investment mentality. All very easy, if you have done it for a few years.
This No Stop system is not for everybody however, and is not the best Forex hedging system since sliced bread, but is does very nicely for some traders, thank you very much. It is important to know about this system as using its principles could help your conventional trading. For freely available information on this No Stop system search the net for no stop forex trading

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ForexGen Hedging System - Make Profit No Matter Which Direction the Market Moves

In the forex trading world, it pays a lot to be a risk taker. Huge amount of profit could be gained if a trader is not afraid to take risks in betting, for a big chunk of the forex trading market revolves around gambling and being good at it. However, in gambling, you either win or lose. If you win, then awesome! But if you lose, then you could just try your luck on a new trade or just walk away feeling sorry for yourself. Now, this could be avoided with the use of forex trading software that analyzes the risks in trading with utter precision.

Examples of this type of software are Forex Tracer and Forex Brotherhood. This type of software uses a forex hedging system that provides an analysis of the forex market and the probable risks in doing a transaction before actually trading; therefore, eliminating the possibility of losing a huge amount of money in unsure trades. With the use of a forex hedging system, no matter which direction the market moves, the trader could be sure to gain profit.

In this process, the trader safely bets on two opposing positions at the same time. This way, one position will gain profit and the other will lose some as predetermined by the automated forex software. Yes, the profit could be relatively small than what you could have had if you won the trade, but you definitely saved your self from danger of losing a great sum of hard-earned money.

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ForexGen | Introduction To Hedge Fund

Although there is no universally accepted definition of the term hedge fund, the term has evolved over time to include a multitude of skill-based investment strategies with a broad range of risk and return objectives. The common element among these strategies is the use of investment and risk management skills to seek positive returns regardless of market direction. Hedge funds are an exciting innovation to the range of professionally managed investment vehicles that have brought sophisticated investment strategies and a new sense of excitement to the investment community.

They can serve as an important risk management tool for investors by providing valuable portfolio diversification. One might define a hedge fund as an information-motivated fund that hedges away all or most sources of risk not related to the price-relevant information available for speculation. Hedge funds use a wide variety of investment styles and strategies. Even among hedge funds that purport to use the same investment strategy or invest within the same asset class, there is a wide range of investment activities, performance and risk levels. Because the investment activities of hedge funds are so diverse, the hedge funds assigned to a particular investment category are likely to exhibit less similarity than more traditional investment vehicles, such as registered investment companies. The investment strategies are typically designed to protect investment principal and engage in a variety of investment techniques that include fixed income securities, convertible securities, currencies, exchange-traded futures, over-the-counter derivatives, futures contracts, commodity options and other non-securities investments in order to generate specific risk-return profiles.

Strategies may be designed to be market-neutral (very low correlation to the overall market) or directional (a "bet" anticipating a specific market movement). Selection decisions may be purely systematic (based upon computer models) or discretionary (ultimately based on a person). A hedge fund may pursue several strategies at the same time, internally allocating its assets proportionately across different strategies. Hedge funds are often classified according to investment style including following categories: relative value, event-driven, equity hedge funds, global asset allocators and short selling. Within each style category, funds are then classified according to the underlying markets traded.

For example, within the relative value style classification, there are a number of sub-groups, including equity market neutral, fixed income arbitrage, convertible arbitrage, credit arbitrage and statistical arbitrage. Various hedge fund return opportunities stem from the expanded universe of securities available to trade and the strategies that can be employed. Funds can access both financial and non-financial (commodity) markets and can easily take long, short, spread, and option positions in any of these markets. Expanding the set of investment opportunities results in providing diversification benefits to a portfolio that cannot be replicated through traditional stock, bond, and real estate investment strategies. For alternative investments, such as hedge funds, to grow as an investment alternative, individuals need to increase their knowledge and comfort level as to their use in investment portfolios.

The logical extension of using investment managers with specialized knowledge of traditional markets to obtain maximum return/risk tradeoffs is to add specialized managers who can obtain the unique returns in market conditions and types of securities not generally available to traditional asset managers; that is, hedge funds. In addition, investors must compare the unique returns available to each of the hedge fund styles to insure that the particular style does not duplicate existing investment opportunities.

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ForexGen Hedging Strategy - Protection against Losses

Many Forex retail traders think that hedging is a good way to minimize losses. When holding on to a losing position, they often take up some form of hedging strategy to protect themselves against further capital depletion.

In this article I will discuss what a hedging strategy is, and why it’s a bad idea for retail traders to consider any type of hedging strategy at all… hedging is not for retail traders!
What Is Hedging?
Basically, hedging involves the buying (or selling) of currency pair(s) in order to protect the hedger against unwanted currency fluctuations. Traditionally, hedging was used to protect the profits of multinational companies from unfavourable currency fluctuations.

Hedging is a great way for these companies to protect their profits, but unfortunately many inexperienced Forex traders have incorrectly applied the same principles to their trading activities. Here’s how a Forex trader may try to hedge his position:Imagine that I buy the EUR/USD currency pair, and the market immediately moves against my position (i.e. prices went down). At this moment, I would be facing an unrealized loss. In order to ‘protect’ myself against further losses, I might sell the EUR/JPY currency pair in the hopes that any gain in the latter pair will partially offset the losses of the former pair.Essentially, I’ll be holding on to two simultaneous ‘long’ and ‘short’ positions for the Euro currency. Hedgers hope that the results of both positions will partially cancel each other out.

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ForexGen Hedging | What is It, and It’s Uses in Risk Management

Before I discuss the use of hedging to off-set risk, we need to understand the role and the purpose of hedging. The history of modern futures trading begins in Chicago in the early 1800’s. Chicago is located at the base of the Great Lakes, close to the farmlands and cattle country of the U.S. Midwest making it a natural center for transportation, distribution and trading of agricultural produce. Gluts and shortages of these products caused chaotic fluctuations in price. This led to the development of a market enabling grain merchants, processors, and agriculture companies to trade in contracts to insulate them from the risk of adverse price change and enable them to hedge.

The first commodity exchange was the creation of the Chicago Board of Trade, CBOT in 1848. Since then, modern derivative
products have grown to include more than the agricultural industry. Products include Stock Indices, Interest Rates, Currency, Precious Metals, Oil and Gas, Steel and a host of others. The origins of the commodity and futures exchange was created to support hedging. The role of speculators is beneficial as they add trading volume and important volatility to what would otherwise be a small and illiquid market place.

A bona-fide hedger is someone with an actual product to buy or sell. The hedger establishes an off-setting position on the futures or commodity exchange, thereby instituting a set price for his product. Someone buying a hedge is known as being “Long” or “Taking Delivery”. Someone selling a hedge is known as being “Short” or “Making Delivery”. These positions known as “Contracts” are legally binding and enforced by the exchange.

Entering your trades either for speculation or hedging is done through your broker. Commodity Trading Advisor, Genuine Trading Solutions President Dwayne Strocen, states that “Commodity and Futures exchanges are distinct from Stock Exchanges, although they operate using the same principals. They are regulated by different agencies such as the Commodity Futures Trading Commission who are responsible for regulation of retail brokers in the USA as well as Commodity Trading Advisors such as us.”

Now let’s view some real life examples of hedging or mitigation of risk by using exchange traded derivatives.

Example 1: A mutual fund manager has a portfolio valued at $10 million closely resembling the S&P 500 index. The Portfolio Manager believes the economy is worsening with deteriorating corporate returns. The next two to three weeks are reports of quarterly corporate earnings. Until the report exposes which companies have poor earnings, he is concerned of the results from a short term general market correction. Without the privilege of foresight, he is unsure of the magnitude the earnings figures will produce. He now has an exposure to Market Risk.

The manager thinks of his options. The greatest risk is to do nothing, if the market falls as expected, he risks giving up all recent gains. If he sells his portfolio early, he also risks being wrong and missing further rally’s. Selling also incurs substantial brokerage fees with additional fees to buy back again later.

Then he realizes a hedge is the best option to mitigate his short term risk. He begins by calling his CTA (Commodity Trading Advisor) and after consultation places an order to sell short the equivalent of $10 million of the S&P 500 index on the Chicago Mercantile Exchange “CME”. Now his result is when the market falls as expected, he will off-set any losses in the portfolio with gains from the Index hedge. Should the earnings report be better than expected, and his portfolio continues upward, he will continue making profits.

Two weeks later the fund manager calls his CTA and closes the hedge by buying back the equivalent number of contracts on the CME. Regardless of the resulting market events, the mutual fund manager was protected during the period of short term volatility. There was no risk to the portfolio.

Example 2: An electronics firm ABC has recently signed an order to deliver $5 million in electronic components of next years model to an overseas retailer located in Europe. These components will be built in 6 months for delivery two months after that. ABC instantly realizes they are exposed to two risks. 1. the rising and volatile price of copper in 6 months may result in losses to the firm. 2. the fluctuation in the currency could easily add to those losses. ABC being a young firm cannot absorb these losses in view of the highly competitive market from others in the field. Losses from this order would result in lay-offs and possibly plant closures.

ABC telephones their CTA and after consultation places an order for two hedges, both for an expiry in 8 months, the date of delivery. Hedge #1 is to buy long $5 million of copper effectively locking in today’s price against further price increases. ABC has now eliminated all price risk. The risk of plant closures is greater than the lure of increased profit should copper price fall. After all, ABC is not in the business of speculating on copper prices.

Hedge #2 is to sell short the equivalent of Euro Currency vs US Dollars. Since ABC is effectively accepting EC in payment, a rising US dollar and a weak EC would be detrimental and erode profits further. The result of the hedge is no risk and no surprises to ABC in either copper or currency levels. A risk free transaction and full transparency is the result. In 8 months with the order completed and the customer accepting delivery, ABC notifies the CTA to close the hedge by selling the copper and buying back the Euro Currency contacts.

Many examples exist to demonstrate the mitigation of risk to an institution or financial portfolio. Dwayne Strocen states that new products are constantly created and available on both over-the counter and exchange traded markets. If would be wise to consult with a qualified Commodity Trading Advisor or broker to discuss the analysis for an on-going risk management solution or a one time only hedge.

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