The decision to enter a substantial financial market like Forex is indeed a noble and accurate choice. It is the world’s largest financial market, and one can proudly be associated with the same. But before you go ahead into this market, you need to realise a bunch of aspects. The market did not turn out to be so huge without considerable elements coming into the picture. Since these aspects are present, it would not be advisable to step in without taking the right form of measures. When these points come after thorough and advanced analysis, you can be assured of strong results. Hence, to shed more light on the same, here’s the essential guide that you need for Forex Trading.
- Analysis for Forex Trading
- Currency Convertibility
- Forex Arbitrage
- Forex Options Trading
- Forex Trading
- Forex Trading Signals
- Forex Trading Strategies
- Forex Trading Tools
- Market Hedge Work
- Natural Hedges
- Patterns for Forex Trading
- Position Trading in Forex
- Risk Management in Foreign Exchange
- Scalping in Forex
- Trading at the Forex Market
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The importance of trading tools is a topic that we are all aware of. Different kinds of insights and market analysis tend to be efficient when you bring in some trading tools. Their requirement rate goes up as you enter markets like Forex. Trading currencies need a little touch of perfection, and these tools are the ideal ones that you need to tag along. But when you move forward to learn more about these tools, you will realise that they are everywhere. There is an abundance of these tools in the market, making it hard for people to differentiate between the good ones and the bad ones. So to help you out, here are some of the best Forex Trading tools.
1. MetaTrader 4 MetaTrader 5These platforms include a vast set of tools that stand to define variety and effectiveness. Real-time trading combined with user-friendly approaches has set sail to create one of the most efficient tools out in the market. The aspect of technical analysis is another concept that makes matters all the more interesting. With this tool in hand, you can be assured of getting the right assistance that comes with a customizable interface.
2. Correlation MatrixThe change of exchange rates in one currency pair when compared to another pair is known as correlation. A set of these currency pair correlations make up a Correlation Matrix. The aspect that you need to understand in this manner is the behaviour of these currency pairs. Some of these pairs correlate strongly as they tend to have a common base current. Since most of them may or may not behave in this fashion, reviewing them will help you in so many ways. It will help you avoid establishing offsetting positions and make matters fruitful. Hence, a tool of this calibre provides the right support.
3. Trade JournalAt times, traders usually tend to forget to keep records of their trade. This moves ahead to bring in various kinds of errors in the future. So the best and the only solution is to keep a record of the same along with an explanation and signals of why and how it was initiated. For this purpose, Trade Journal comes into the picture and helps you examine mistakes, thereby preventing you from repeating the same. A paper journal, spreadsheet or even a trade journal will help you do the trick.
4. Time Zone ConverterThe difference that time zones bring in for the trade is not something too light to be ignored. Leading Forex trading centres tend to overlap sessions during specific periods of the day. These overlaps are the most liquid markets for particular currency pairs. For this purpose, it is quite essential to know what trading sessions are open and what times are the best for trading. Taking into consideration aspects like volatility, liquidity and trading volume, you can make the most out of the same. Thus, a tool like Time Zone Converter holds prime importance.
The guide to surviving in the Forex market tends to include a unique concept that has brought forward numerous benefits. Known as an advanced strategy, this particular concept has made investors happy by helping them tackle down a long list of problems. To avoid all the guessing work since it is clearly mentioned above, let’s cut to the topic and talk about Scalping in Forex. The advanced set of strategies that it brings to the table is required to help run aspects through the market and make you wealthy. Hence, let’s learn more about this advanced concept known as Scalping.
Choosing is a broker for your scalping strategy is another step that you need to execute. For this purpose, you must cross out brokers who do no allow the process to take place within the system. According to the current market stats, numerous brokers are not supportive of the idea of closing trades. As a result, these brokers do not provide ECN execution systems and other tools that promote the strategy. Considering all these features, your list of brokers needs to get shorter until you find one that suits all your needs. Towards the end, when the factor of costs arrives, we believe that you would have made a decision.
The IntroductionIn simple terms, Scalping is nothing but a strategy that works based on real-time technical analysis. When it gets mixed with Forex, the method moves ahead to make a large number of trades to produce small amounts of profits. This is achieved as the process does not hold a position for a long time. It tries to gain pips by holding a position for a couple of hours, days or weeks. Anything beyond that is not considered to be Scalping.
The ProcessThe practical application of Scalping for Forex tends to take place as traders scalp currency pairs by using a specific time frame. These periods last between 1-15 minutes. But the traders do not usually opt for the 15-minute time frame as they believe it to be less effective. As a result, the 1-minute and 5-minute time frames are the most common choices. These are known to bring out a profit of 5 and 10 pips per trade, respectively. But for this to scale through, you also need to pick a currency pair that is volatile and predictable.
The DecisionThe decision to opt for Scalping is one that needs to be taken after some consultation. Soon after you understand the method, you need to think about the time that you’re willing to put into the trade because Scalping requires timings that can be related to a full-time job. Yes, that’s right. Constant analysis, placements and multiple orders tend to take hours, and at times they might even be stressful. Your predictions of the market is another aspect that is deemed to be necessary. Based on your analysis, you must quickly open and close positions that should not take more than a few seconds.
Foreign exchange risk, for those who are not really aware of what it means, can be referred to the losses incurred by an international monetary transaction owing to certain fluctuations in currency. Foreign exchange risk (FX risk), which is otherwise also known as currency risk, describes that the value of an investment might depreciate due to any change that might be observed in the relative value of the currencies involved in the transaction. This is, in a nutshell, the essence of foreign exchange. However, it would be puerile to restrict the domain to just the definition and provide no further insight into the topic at hand. Though, the entirety of foreign exchange might not be possible to wade through within the span of one article, there are a few essential points that you must understand to be able to understand the topic better.
An Insight into Foreign Exchange Risk:As we have already stated at the beginning of the article, foreign exchange risk refers to the risk associated when there are significant losses incurred by an international financial transaction due to fluctuations in the currencies involved. Any kind of appreciation or depreciation in the base currency or the denominated currency will have an impact on the entire system of cash flow arising as a result of the transaction. The domain of foreign exchange affects several investors and business people who have to deal with international transactions on a daily basis. Therefore, understanding the inherent risks of foreign exchange is all the more important to these people, without which they could end up in a soup.
A Few Foreign Exchange Risk Management Techniques:Now that we have spoken about what a foreign exchange risk is, it is time to look into a few techniques in which these risks could be managed.
Risk Sharing-Just as the term suggests, the parties involved in the transaction (for instance, the seller and the buyer), agree to share the burden of the risk associated with the transaction so that their relationship is not affected and depends solely upon the quality of the product and the reliability of the supplier.
Payments Netting-This method proves to be beneficial to the companies that are exposed to transactions involving multiple currencies. The technique allows the companies to control the way the payments are dealt with since all the payments are netted to a singular transaction.
Natural Hedging-This method of foreign exchange risk management offers the firm quite some protection from the fluctuations in exchange rates because the relationship between the revenues and costs of a foreign subsidiary body furnishes a natural hedge.
Conclusion:The right implementation of one or more than one techniques can shave down the risk associated with the foreign exchange transaction and help a firm thrive. It is always crucial that you remember that transactions that involve foreign currencies have risks associated with them. But that does not mean that you have to give in the risks and suffer from the losses. You can always use the techniques mentioned above to hedge the risk and make a favourable transaction.
Forex options trading is an important branch that many seem to be ignoring. The basic meaning and what it moves ahead to prove are essentials that traders need to be aware of. Be it the strategies or the methods that it proposes; everything tends to have a unique connection to the market and thus, it manages to be effective. So the question of utilization should not come up, and everyone needs to make an effort to try the same. Since that may not be possible without venturing further into Forex Options Trading, we are here to help you out. Hence, here’s all that you need to know about Forex Options Trading.
1. What is it?Forex options are nothing but a bunch of derivatives that are based on specific currency pairs. Trading the same brings in a set of strategies that are immune to the Forex market. So the option to choose a particular strategy can be answered after looking into the type broker, the platform and the option that a trader selects. Once all these aspects align together, you will have a strategy. Since the market is a decentralized one, these options tend to vary in nature and character. They move forward to be unique and can be differentiated from the ones that are chosen for the stock market.
2. What you need to RememberDue to the path within which these strategies move, certain things stand to be necessary. If you’re an investor planning on choosing Forex Options trading, then here is a list of points that you need to be aware of.
- Lacks Obligation – the options that you’re about to choose will not be having an obligation to deliver a physical asset. This is a common ingredient for Forex Options trading and investors usually amend their ways before opting for the same.
- Two Main Varieties – the Forex options tend to come in two main varieties, and there is nothing more to the same. These are known as Vanilla Options and SPOT Options. So the decision lies in your hands.
- Differentiates – as you move from one product to another, you will also realize that these options vary based on the entity that they are offering.
3. What are the types of Forex Options Trading?The two types of options commonly available for retail Forex traders tend to be currency options trading. They mainly involve short-term trades of a currency pair that aims at future interest rates of the same pair. So, let’s look into these types.
- Vanilla Option – the Vanilla option also goes by the name of options contract and is considered to be the traditional call. With this option in hand, traders have the right to buy or sell currency at the agreed-upon terms and conditions but are not obliged to do so. These so-called terms and conditions include price and the date of execution. The basic process occurs when the buyer states how much they want to purchase and the price at which they wish to purchase, along with the date of expiration. On the other hand, the seller responds with a quoted premium. The date of explorations tends to revolve around European or American style options.
- Spot Option – SPOT stands for Single Payment Options Trading and is known as the flexible option out of the two. Digital and Binary options are few of the other names that used to describe this option. The process takes place when the buyer offers a scenario stating that a specific currency pair will break at a particular point within a set of days. Based on the probability of the same, they will receive premium quotes. If the so-called event takes place, then the buyer will earn a profit, and if it doesn’t, then they will lose the premium that they paid. These contracts cannot use premiums from traditional options since they need to be higher. After they reach a certain point, other points or if it does not reach at all, they will be written to payout. Since specialized options come into the picture, premium requirements tend to be higher when compared to the rest.
Trading could be superficial or intricate, depending on the perspective you like to take on the field. Forex is one such domain which is layered and is to be explored for its potentials. When you want to take the backseat and relax on the journey of forex trading, there isn’t much chance for you to get to the point of complexity. But as you take the driver’s seat with all the directions posing a challenge to ride through, forex trading will start to appear complicated. On the surface, like any other concept, forex trading is also simple; delving deeper will equip you with perpetuating data about forex trading. The marketplace that has been made for the trading of currencies is the right platform for traders to make speculations of the profit and conduct well-composed commerce. Forex trading is widely popular as the largest exchange in the world and is, therefore, used by thousands of brokers, individual traders, banks, and other investors. Forex trading is most often conceptualized as the field for indulging in a currency trade with nothing more than picking the direction of a currency pair to be focused on by the trader. The facts are contradictory to the world’s conception of forex, which calls for experience and patience to invest considerable time in the trade. Technical and fundamental analysis of the trading business has to be done on subtlest of levels. Also, you need to have an in-depth understanding of the market and the factors that affect its conditions. You can only find forex trading systems on the Internet that are virtually supportive, the remaining of which you need to fill with your efforts. Of all the information related to forex trading, it is position trading that we will have a closer look at. Position trading is one kind of trading in forex, which has to be learned by every trader who is planning on going deeper into the business.
Daily and weekly charts will consist of resistance levels and key support which hold significant value in position trading. The professional traders most prominently focus the higher time frame charts for analysis.
Position TradingAlthough position trading is referred to as a type of forex trading, it is, in fact, an investing style that has speculative traits to it. This pattern is most followed by the traders when they take an interest in the long-term trends and prices in the market. Position trading has its own set of characteristics with the traders preferring only a handful of major positions. Nevertheless, they can go for any of these positions all through the year for active trading. When you are a position trader, and this style is your forte, you surely will have reasons to stick to it. One such reason for almost all traders would be the opportunities they receive which last for a few months or even for more than a year. Fundamentals of the trade have to be learnt properly before stepping into position trading since its life of more than just a few months. What every position trader has to be conversant with is the art of smoothly falling into that place when the opportunity within the market strikes and coming out of it as that period ends. It isn’t the elegant virtues you possess that matters the most here; technical knowledge about the timing models that need to be followed plays a key role.
Who is a Position Trader?A position trader is one who indulges in forex trading with appropriate multi-year or multi-month trend evaluations as compared to the current situation or emergence. They do not act like that of the swing traders who look for active day investments and trends to trade. Position traders like to take the seat for a long time without having to adopt new trading steps every passing day. Previous trends show that most of the inexperienced retail traders go for the short-term day trading option, while the professional Commodity Trading Advisors and Hedge funds incline towards position trading.
Necessary Tools for Position Trading in ForexSince technical analysis is suitable for timing a long-term trade, it would appear to be the most important in position trading. In contrast, the price action analysis stands as a reliable one for long-term charts. Such analyses are essential in getting to successful trading times, for which, tools are required to notify you with the right opportunities. Here are some of those necessary tools for position trading.
Trend Line IndicatorThis is said to be one of the most effective tools in picking the right opportunity since it offers a proper insight into the trading market. With the price action and trends being more apparent on the longer time frame charts, position trading becomes more profitable. The trend line indicator helps by giving a clear directional bias on the market trends and highly prevalent price action.
Support and ResistanceAs mentioned earlier, resistance levels and horizontal support play principal roles in position trading. A higher resistance level is likely to come into action when a major resistance or support is broken on the chart by the price action. This rise happens when there is an upside break, whereas when a downside break occurs, the resistance level is likely to decline. When the break doesn’t take place, and the price action falls into the opposite direction, you have to either consider it as a price rejection or be alert for an impending trend in the opposite direction.
Moving Average IndicatorsWhat matters the most while using the Moving Average Indicator is the longer term’s number of periods that you utilize. The moving averages most often will have a longer-term price action in the 50 and 200-period zones, while you also have to pay equal attention to the 100 and 500 periods moving average.
Most Important Economic IndicatorsPosition traders will also have to keep a tab on the economic trends, which necessitates a few indicators. While analyzing the macro-economic data for long-term position trading, look out for the indicators such as inflation rates, interest rates, trade balance, and economic and political stability.
As the name suggests, currency convertibility is all about the ease with which the currency of a country can be converted to other valuables like another currency or gold. This concept has had a significant role in the life of the world economy; it indeed is a key aspect of the seamless functioning of international commerce. All goods that are sourced globally undergo all stages of trade upon a mutual agreement to be paid in a currency that is not the buyer’s domestic currency. A currency’s value can be determined from the convertibility it possesses. With poor currency convertibility, the chances for it to have a high storage value or get swapped for other currencies are quite low. Such currencies with a low value for convertibility will pose a huge risk to the domestic market and economy within those countries owing to the disinterest the other countries express in trading for the domestic currency. World trade has one of its pillars set on currency convertibility since it is the factor that leads to exponential growth in the capital flow between countries. The need for currency convertibility was felt at a point where the world economy was seemingly in a precarious state without supporting the standard living conditions through essential trading. The use of foreign exchange was regulated by many countries to maintain a decent exchange rate for their currencies.
A Closer Look at Currency ConvertibilityIn the simplest terms, currency convertibility is the value for free conversion of a country’s currency into the foreign exchange at market rate as determined by the demand and supply. When you have foreign currency (Euros, Pound Sterling) with you and want it converted, currency convertibility comes into play. You can get it converted it into your domestic currency at the exchange rate that has been determined by the market. Authorized dealers such as banks provide proper conversion rate data based on which you can get the money exchanged for your domestic currency or vice-versa. Only on the capital and current accounts for import and export of invisible and merchandise is the currency convertible. In capital account convertibility, the flows of portfolio capital, direct investment, dividends and their interest, and borrowed funds are easily convertible into the foreign exchange at the fixed exchange rate. In less complex terms, capital account convertibility can be defined as the ease with which foreign investors can access industries in your country through the domestic stock markets by converting their money into the domestic currency even without the government’s permission. Stability of currency is imperative for the capital account convertibility to function flawlessly. An impeccable performance of the concept within the market cannot be expected of always since the volatility could set in anytime. Therefore, the convertibility over capital is considered to be quite risky, making it valid only after the introduction of current account convertibility which will also entail the stability of currency and control of the deficit in the balance of payments.
How Will Currency Convertibility Benefit You?
- The potential for high profits makes export an indispensable part in the market. For the same reason, currency convertibility promotes the business of exporting, consequently adding to its profitability. This rise in profit occurs due to the increase in the exchange rate from the previous market fixed exchange rate. Products that have a lower intensity of import are highly promoted by currency convertibility for exports.
- Import substitution is encouraged more when the imports fall with rising expenses due to currency convertibility. This situation is caused when the market-determined exchange overtakes the value of the previous fixed exchange rate.
- Currency convertibility also provides incentives to the remittances of foreign exchange by the non-resident citizens and ones living abroad. This step reduces gold smuggling and the inflow of illegal currency formats into the country.
- Deficit balance of payments caused by over-valued exchange rates can lead to depreciation of the country’s currency, which in turn will boost the exports. These can be achieved by reducing the imports and raising their prices and also taking down the prices of export. The deficit gets corrected in the process without much of an intervention by the Central Bank.
- Prices of goods and in a country will also affect the purchasing power of a currency, which will be further influenced by the currency convertibility. Currency convertibility will, therefore, make sure that the various trading countries have their specific production patterns and international trade ensured through comparative advantage.
- Since currency convertibility boosts the capital flow and trade between countries, the chances for the world economy to fall are reduced, and a firm ground is held onto as the value of currency maintains consistency. Hence, it can be concluded that globalization has its strongest roots in currency convertibility.
Types of Currency ConvertibilityThe International Monetary Fund has set three crucial aspects which have to be conformed to by the currencies for it to be convertible. Usability, exchangeability, and the exchange value of a currency are the factors that determine its convertible value. Currencies all across the world have to satisfy these standards set by the IMF, which according to the variation in its compliance will differ in its convertibility. Currency convertibility has been classified into three depending on these standards:
Fully ConvertibleCurrencies that have sufficient value to be freely or fully traded at any point of time without any conditions to limit it are known as fully convertible currencies. Almost all the wealthy and stable countries like the US, Japan, Switzerland, and the UK have fully convertible currencies.
Partially ConvertibleThe currencies that can be traded only with certain restrictions imposed on them by the issuing government are tagged partially convertible. Less stable economies hold such currencies, which include the South African rand, Malaysian ringgit, and Chinese yuan.
Non-ConvertibleCurrencies that hold no value to be traded at any point of time on the foreign exchange market are tagged non-convertible. It is also known as blocked currency, one of which is the Venezuelan bolivar.
The Forex market opens its door for an endless supply of opportunities. It’s size, and aspects involved within its functionality has helped individuals come out with different kinds of strategies. With the end goal of earning profits and considerable returns, these strategies are tested. If they tend to provide an individual with positive results, then everything will head in the right direction. Otherwise, the strategy will not be considered, and traders will begin to ignore the same. On that front, there is a particular strategy that has been tried and tested. People who have utilised the same have come out with excellent results. Since we hate to keep you guessing, you need to know that we are talking about the Arbitrage or the Forex Arbitrage Trading strategy. So if you wish to gain more details about the same, then go ahead to learn more.
What is it?Forex Arbitrage is a unique strategy that gains momentum by exploiting the price disparity. It tends to act upon various opportunities that are presented by pricing inefficiencies that exist in the short window. For this purpose, it buys and sells different currency pairs with the primary purpose being to utilise an apparent inefficiency to a large extent. So to gain a deeper perspective about the same, let’s look into an example. Imagine that the currency rates for EUR/USD, GBP/USD and EUR/GBP are 1.1837, 1.6388 and 0.7231. In such a scenario, a trader can purchase a mini-lot of EUR for $11,837. Soon after that, the trader can proceed to sell the same at 10,000 Euros for 7,231 British Pounds. In order to earn a profit, the 7,231 GBP can be sold for $11,850 that lands a profit of $13 per trade. This move also avoids open exposures since long positions tend to cancel short positions in each currency. The same trade can also be functioned by using normal lots of 100,000 that would, in turn, bring out a profit of about $130. From the above example, it is quite clear how the system tries to utilise inefficiencies in order to correct a particular problem. But in such cases, traders also need to act quickly since these opportunities do not stick around for a long time. The short term nature of the Arbitrage needs to be understood by all means.
Points to be Noted
- Efficient – the arbitrage trading strategy not only helps you gain a balance over your investments, but it also helps the markets to be efficient.
- Circumstances – the process of Arbitrage will not be possible without the involvement of unusual circumstances.
- Temporary – the situations that promote you to perform this strategy are usually temporary and will not head for the long term.
- Fewer-Risks – since the process tries to make a profit with no open currency exposure, it tends to include fewer risks.
What Are the other Forms of Forex Arbitrage?Thanks to the dynamic nature of Arbitrage, you can be assured of witnessing different forms. So to gain more clarity, let’s take a look into a few of these types.
- Currency Arbitrage – the aspect of currency arbitrage works with a different style of functionality. Instead of going for the movements of exchange rates, it looks into the differences in quotes of currency pairs.
- Covered-Interest Rate Arbitrage – this is another method that tends to utilise favourable interest rate differentials for the purpose of investing in high-yielding currencies and then hedges the exchange risk with the help of a forward contract.
- Triangular Arbitrage – a typical triangular arbitrage or cross-currency transaction is one that does not include the U.S dollar when it comes to pairs of currencies. It usually involves Yen and other forms of ordinary currency pairs.
- Spot-Future Arbitrage – this particular form of Arbitrage is something that has not been used by a lot of investors. Although they tend to quote their preferred reasons for the same, we firmly believe that it works through. The process is simple, and it involves taking positions in the same currency in a spot and future markets. But for this to click, one has to wait for pricing discrepancy. Since our markets tend to face different kinds of elements, it will arrive sooner or later. So by all means, an investor has to buy currency on the spot market and then wait to sell the same in the future market.
- Uncovered Interest Rate Arbitrage – this is a pure arbitrage that involves the process of changing a domestic currency, carrying a lower interest rate to a foreign currency that offers a higher interest rate.
What are its Challenges?Since most of these strategies take place within the Forex market, it is quite obvious that it comes across specific challenges. On that front, it is now time to look at some of the many challenges that it faces.
- Unforeseen Circumstances – although Arbitrage thrives on unforeseen circumstances, certain situations manage to be problematic towards the process. A discount or premium is one such aspect that can hinder the strategy. When such discounts and deals come into the picture, they tend to bring about market liquidity differences. This is not a price anomaly, nor is it an arbitrage opportunity.
- Slow Trading- as we all know; Arbitrage requires a rapid platform or entry in order to make matters meet. Slow trading platforms or delays can limit the entire process and put it on hold. This tends to kill the rapid action that it requires and will permanently ruin everything for the worst.
- Limitations for Small Traders – the aspect of lending and borrowing for Arbitrage takes place at risk-free rates. Such kinds of rates are usually available only at large financial institutions and corporations. Thus the process leaves out smaller banks or traders who simply cannot afford these enormous costs. The margin cost overhead and spreads are additional factors that reduce the possibility for small traders to cast a spell with Arbitrage.
Natural Hedges is the risk reduction that can arise from normal operating procedures of an institution. A company having sales in a country holds a natural hedge on the currency risk of the country if that country is also generating expenses for the company. The typical financial hedge act in a manner which opposes the movement of underlying securities of a transaction. In the case of natural hedges, the risk is naturally reduced with the means of operations of an institution. The natural hedges are less flexible and work according to the exchange rate movements. If the exchange rate swings to one side, the operations will be expensive but will also offer higher income. In the other case, the operations will be more affordable, but the income will also go down. Natural hedges can be beneficial during improved operational levels. Natural hedges are also applicable in case of financial assets such as bonds. When the stocks rise, the bonds perform poorly, but when the stocks fall, the bonds become better. It makes the pair a natural hedge against each other. The process of buying long and short positions in stocks are also correlated and develops a natural hedge. So far, we have discovered that Natural Hedges are not flexible and offers a consistent benefit or loss according to the operations. It cannot be controlled by investors and can only be used during beneficial times. Let us now look at how natural hedging affects the financial market.
A company should go for hedging when there is a significant benefit in it. They should process the potential impact of the commodity or product that they will use for hedging. If the impact is not big enough, hedging will simply be a poor investment. The best strategy is to use hedging when it can make a difference in mitigating risks.
Natural hedging in financesThe portfolio managers look for hedging the downside risk, which also includes natural hedging. The assets that have been performing opposite each other constantly suit natural hedging. The portfolio managers need to specifically look for the historical trends of an institute while selecting a natural hedge. For example, when the equity grows higher, the bonds are shorted in order to cover the downside risk. Bonds can also go higher sometimes, which will tell that the equity has been performing poorly. Another way for natural hedging is to choose pairs trading. A portfolio manager picks up two stocks that are correlated, and if one stock performs well, it will offset the other stock.
Benefits of natural hedgingNatural hedging can provide consistent benefits while reducing the risk of investing on a single side of an institute. It helps in minimizing the risks and helps in the management of investments to avoid the downside. It will assure profits one way or the other and helps a company to survive the challenging market conditions. The investors and traders can also protect themselves from the volatility of price, inflation, and interest rate changes. Natural hedge provides a consistent profit without the need for constantly monitoring the market for adjustments.
Downsides of natural hedgingHedging limits the profits to a certain extent and can even reduce the profits even further. As there is a low risk of downfalls, the rewards are also not higher. Natural hedging only offers low rewards. The portfolio managers need to constantly do hedging in order to efficiently control their portfolio. Overall, natural hedging boosts the valuation, increases the ability to raise capital, and provides tax benefits. It is a great way of entering a new market and starts earning profits until you can create your own hedging and investment plans.
Natural Hedge and Financial HedgeThe main difference between natural hedging and financial hedging is that natural hedging is less flexible. But natural hedging does not need operational changes as it happens naturally according to the operations of the market. It also makes natural hedging easy to work with as it does not need complex financial products like derivatives or forwards. Even though both the hedgings are two different strategies, a company can use both in order to acquire maximum benefit. A company which deals in a commodity can shift their operations to a new country where they can sell their products to natural hedge against the currency risk. Later they can use contracts to hedge their risks even further.
Not many of us would be acquainted with the term Money Market Hedge and for reasons that are understandable. We do not deal with Foreign Exchange in our daily lives, and that is why we are not really supposed to know what the term means. But for those who are interested in making a career in foreign exchange and are trying hard to understand what the domain has to offer, you must be first oriented with a set of jargons. One of the most important jargons used in the discipline of foreign exchange is that of Money Market Hedge, and with this article, we shall try to provide an insight into what this means and the ways in which it works. Therefore, without any further delay, let us delve directly into the topic at hand.
What is a Money Market Hedge?A money market hedge is a technique used to minimize the risks associated with foreign exchange. Simply put, it is a process that hedges the risk factor involved in a foreign exchange transaction in the money market, where short-term investments that are highly-liquid, are traded. Some of these liquid and short-term investments are banker’s acceptances, treasury bills and commercial papers. However, of all the foreign exchange risk management techniques that we have in the market, the instrument of money market hedge might not be a cost-effective one, especially for large organizations who deal with a high volume of trade and exchanges. However, for smaller businesses and investors, managing risks in the domain of foreign exchange with money market hedge is one of the best ways to stay cushioned against the various fluctuations in currencies. This is because these small ventures do not need to use the futures market or forwards contract, and thus, this technique serves to be quite efficient.
How Does the Money Market Hedge Work?The money market hedge is quite similar to a forward exchange, but of course, there are certain vital differences as well that we are going to be looking into. But first, you need to know why foreign exchange risks occur. There are primarily two reasons why a risk arises in foreign exchange. The first is due to transaction exposure, and the second is due to translation exposure. Hedging the risks associated with translation exposure with a money market hedge might not be possible because it is quite a complex process. But the transaction exposure can be very well hedged with this instrument.
Implementing the Money Market Hedge:There are a number of scenarios where you can implement the money market hedge, and some of these instances are mentioned below for the sake of your understanding.
- In a situation where forward contracts are not available, the money market hedge can be implemented effectively.
- Money market hedge can also be used in small businesses where they do not have an access to the forwards market.
- Also, the instrument of money market hedge can be used in situations where only smaller amounts are required and where there is a requirement for currency hedge, but without using the currency options.