Hedging Foreign Exchange Risk

Trading on the foreign exchange markets is gaining more and more popularity. One can earn a good amount of money from forex trade. But forex trading always carries risk. Almost all the traders are looking for new ways to reduce their level of risk in forex. One of the more important methods of reducing risk in currency trading is foreign exchange hedging.

Hedging in foreign exchange is a method of reducing risk where you can make larger return on your forex investment with minimum risk. Foreign exchange hedging simply is a transaction that is made by a particular forex trader to protect an established position against an unanticipated or unwanted movement in the market.

Hedging foreign exchange risk helps you to reduce your level of risk and at the same time increase your ability to leverage your positions. Read the article below on forex hedging to know more about them.

The risks in the foreign exchange market can be effectively hedged in the following ways:

A forward agreement is made between the holder of the currency and the buyer so as to reduce the risk of the fall in the price of the currency that you are presently holding. In this agreement, the buyer and the seller agree to trade the currency at a particular rate. This way, whereas the seller is protected from fall in the price of the currency and the buyer is protected from increase in the same.

Future trading is very similar to forward agreement, where the buyer and the seller agree on a price for trading forex. The only difference being that forward is an agreement that takes place on a predefined date in future, while futures transactions are done on a different platform, known as the futures market.

In option trading, the two parties decide on an agreement where, if the price of the currency decreases, the seller can sell it at the fixed price as per the agreement, which protects him from making a loss on the currency. The option is that if the price increases, you can sell it at the increased exchange rate and make profit.

A very low risk form of forex hedging, in a swap contract, the seller and the buyer exchange equal starting principal amounts at the current spot rate. Exchanging fixed or floating interest rate payments, during the term ,at the end of the contract period, both parties re-swap the currencies at the predetermined rate and thus end up with their original currencies.

Hedging in foreign exchange can really work if you know how to implement it correctly. Going through the above article on hedging foreign exchange risk will help you to trade more confidently with minimum risks.