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Forex Hedging Strategies

Forex hedging occurs when a currency trader enters into a trade with the intent of protecting an existing or anticipated position from an unwanted move in the foreign currency exchange rates, just think of it as like an insurance plan. In other words Forex hedging is simply coming up with a way to minimize risk. Forex hedging can help to reduce the amount of loss that would incur if something unexpected happened. This does not always mean that when a negative event does occurs that it will always possible to out of it completely.

The development of any Forex hedging strategy is create a portfolio that includes an analysis of the forex trader’s risk exposure, risk tolerance and consisting of a long position in the foreign currency asset and a short position in a foreign currency asset so that the gains on one offset losses on the other. Using drivatives with price movements that are correlated with the movements in the spot market. The Forex trader must identify what types of risk (s)he is taking in the current or proposed position. From there, the trader must identify what the implications could be of taking on this risk un-hedged, and determine whether the risk is high or low,
to determine the risk tolerance or the exchange risk in the current forex currency market.

Derivatives that have been to proven live up to the requirements for an effective hedge are able to qualify for special Forex hedge accounting treatment. There are three types of hedges in the Forex market that meet these requirements: the fair value hedge, cash flow hedge and the hedges of corporation net investments in foreign operations.

Forex hedging ifself has some risks, however they can be limited and controlled with simple attention to the fundamentals. Any forex exchange risk with any Forex hedge can include forecast inaccuracies, leading to unexpected price variations, either up or down. For those Forex traders lacking adequate trading experience could trigger big losses.

There are two primary methods of Forex hedging currency trades for the retail forex trader:
Spot contracts, and Foreign currency options.

A spot contract is a binding obligation to buy or sell a certain amount of foreign currency that happens to be made by a retail forex trader. This is usually done in two business days. Spot contracts are not the most effective currency hedging vehicle.

A foreign currency option can give the owner the right to buy or sell the indicated amount of foreign currency at a specified price before a specific date at a pre-agreed exhange rate, but without obligation. For this right, a premium is paid to the broker, that varies in amount according to the number of contracts purchased. Foreign currency options about hedging found in Forex trading are one of the most popular methods of currency hedging.

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