What is hedging?
Hedge is a kind of insurance. Hedging currency risks is actions meant to lessen risks related to volatility of foreign exchange rates. When traders decide to hedge, they decide to protect themselves from possible losses.
However, it is difficult to grab the principle of hedging from a simple definition. We are going to enlarge on tools, types, methods, and strategies of hedging deals on Forex as well as give some examples.
Hedging tools
Key hedging tools include financial derivatives such as futures and options.
- An option gives its owner the right to buy or sell a chosen asset at an agreed-upon price in the future.
- Futures obligate the owner to purchase or sell an asset at a predetermined future date and price.
These tools can be applied separately or combined. There is quite a number of such combinations.
Hedging strategies
A wisely chosen strategy increases success chances. Here are listed some of the strategies.
Hedging futures. Selling futures in the derivatives market in the volume compatible with the volume of hedged goods.
Buying put options. A put option gives you an opportunity to sell futures at the time and price convenient for you. When buying a put option, you fix the minimum price so you can profit from a higher price in the future.
Selling call options. A call option seller will have a bit bigger advantage than a call option buyer. The latter one will have a reward from selling every unit of a call. The seller can sell futures at the execution price.
When choosing a strategy, take into account the current economic situation and all possible prospects and keep analytics in mind.
What opportunities does Forex hedge give?
Funds kept in foreign currencies are prone to currency risks. A company’s accounting is usually carried out in one currency, which means some profits or losses may appear when re-evaluating items in another currency due to different exchange rates. Hedging currency risks allows the company to protect its funds from undesirable and unpredictable changes in exchange rate dynamics. The company fixes the value of current funds through trades in the international currency market.
Hedging helps the company avoid risks of currency fluctuations and plan further work. It also shows real financial results not affected by currency volatility as well as production value, corporate revenues, wages and other expenses.
Using leverage, when hedging currency risks, gives extra opportunities:
- Allows a company to save significant sums of corporate cash flows;
- Allows a company to sell currency that it will receive in future.
Hedging corporate risks at foreign trade operations implies opening a currency position opposite a future funds conversion.
For example, an importer opens a buy deal on a certain currency beforehand and closes it once the real purchase in the bank takes place.
An exporter, on the opposite, sells foreign currency and has to open a sell trade beforehand and close the trade when the real sale takes place.
Example of hedging on Forex
Suppose an importing company has been awaiting a shipment of a certain value from the United States for n days. The company has euros on its account. To make a deal, the company has to convert its euros into the US dollars. The company decides to hedge risks of a sudden surge in the greenback. With the 1:1,000 leverage, around 1% of the sum that will be hedged should be invested. If the dollar starts rising, the company will suffer losses; however, profits generated from the opened trade will offset the losses.
Therefore, the currency exchange rate is fixed; and profits with losses equal zero. As a result, the company does not need to worry about undesirable changes in currency rates and saves money for other operations.
How to hedge your funds against currency risks right now?
First of all, you need to open a trading account with InstaForex which renders currency trading services.
If you want to make your company’s cash flow predictable and you know volumes and terms of goods selling, our specialists can open certain market positions to help you avoid losses. If you have any questions, feel free to contact us at support@instaforex.com. Even if you have never hedged assets, we will clearly explain how to do it and develop the plan that will suit your business the most.
