FX Hedging. How do you use forex hedging to protect yourself and limit your downside while making money in the forex market?
Forex Hedging Terms
Here are the basic forex hedging terms you must understand before you get started:
- Cross Rate – A cross rate is a currency pair that does not include the US Dollar. An example would be SGD/GBP.
- Nominal Exchange Rate – This is the most straightforward form of the exchange rate, the price of the domestic currency in terms of the foreign currency
- Real Exchange Rate – The real exchange rate is the nominal exchange rate adjusted for changes in price levels in the foreign country.
- Spot Exchange Rate – The spot exchange rate is the current exchange rate
- Forward Exchange Rate – The forward exchange rate is an exchange rate traded today but scheduled for delivery at a specific date in the future. Thus, you can even trade futures forex contracts
Hedging Forex with Futures
The Forex market can be highly volatile. In order to protect your investments, Forex hedging is an important skill that you need to master. There are a few ways to hedge forex investments. First, you could consider purchasing forex futures. For example, with the emini Euro FX contract, you could take a long position in the spot market and a short position in the futures market. This hedges you against unexpected forex movements.
Hedging Forex with Options
Options are another excellent way to hedge your forex investments. If you go long on a forex position, you should buy a long put position that is out of the money in order to hedge your position. More about Hedging with Options.
Currency hedging protects your investments by minimizing the influence of exchange rate fluctuations, thereby stabilizing your earnings and cash flow. Forex hedging is a powerful strategy that you should definitely master.