Using the Forex market to hedge the risks of currency

Forex market: When most people think of the Forex market, their minds are the pros and cons of forex trading. And while it is possible to make money trading currencies in the forex market, it is important to note that the currency market also has other purposes. The smart money manager can cover different risks of currencies with the help forex market, whether those risks come from their income or whether they come from global investments denominated in different currencies.

Covering the Risks of Income with Forex Market

If you work for a global company, working as a contractor or live in a foreign country, you may find that your salary is denominated in a currency other than the currency you used to spend money currency. If you work for an American company and receives his salary in dollars, but lives in Japan and does most of its expenses in yen, you may realize that changes in the exchange rates of currencies may mean an increase or reduction in salary de facto.

If the exchange rate for USD / JPY is 77.00, that means if you expect a salary of $ 10,000 a month, you would receive 770,000 yen. However, if the exchange rate falls, albeit slightly, to 76.00, end up charging only 760,000 for the month. Your employer does not pay less, but the exchange rate reduces their purchasing power at 10,000 yen.

In order to protect against this loss, you could open a position at the beginning of the month, to go short the USD / JPY. You not even need to open a huge position. A pip of a mini-batch of yen are 100. Therefore, if the exchange rate falls, lowering the dollar against the yen, if it goes short USD / JPY, that would translate into a gain of 10,000 yen in forex market, offsetting the difference between 770,000 and 760,000 yen. (If the USD / JPY rises instead lose 10,000 in the currency market, but their purchasing power increased to 780,000 yen, will mean that no overall net loss)

Things to remember when hedging currency risks in this way

The most important thing to remember when covering risks of their income is going long on the currency used to spend and short of the currency in earning his salary. Therefore, if you live in the euro area, but earns money in dollars, will go long on the currency pair EUR / USD. And, conversely, if he wins in euros and lives in the US, he would have to go short the EUR / USD.

We also must understand that cover is not about making money in the forex market; it is to limit losses in purchasing power due to changes in foreign exchange rates. This means that you should close your position every month, record your gain or loss, and immediately re-open the position. Note that the question is to prevent revenue losses following a depreciation of the currency and nature of coverage means you will not see benefits.

Using the forex market to hedge the risk in the stock market

You can also use a similar strategy to cover the risk in the stock market relative to foreign investment. If you invest in foreign markets, using different denomination coins, you risk seeing their returns weighted by a depreciation of the currency or see their losses multiply. For example, if you invest in an offshore fund following the FTSE 100 index and the pound lost value against the US dollar, then its conversion to US dollar means that earnings FTSE 100 will be reduced. If the FTSE 100 falls during this time, their losses will be magnified by the depreciation of the currency.

You can use the forex market to hedge against such risks. If you are concerned about the depreciation of another currency, you can go short of it. If you are ready to sell some of its shares on the bottom of the FTSE 100 and is concerned that a fall in the pound can be a problem, you can go short the GBP / USD. Thus, when the pound falls, you can use the proceeds to compensate for investment losses. This strategy can work with a number of investments, including real estate and raw materials.

Final conclusion

Whenever you are worried that the exchange rate of the currencies may lead to currency risks, if it comes to a reduction in purchasing power, or investment losses, you can use the forex market to hedge their risks. Even if still recorded net losses, a hedging strategy can help limit your losses, so they will not be so great.