Hedging

On occasion, Forex traders might seek something of an “insurance” against an undesirable switch in exchange rates. If so, they will use a method known as hedging.

By using a Forex hedge, a trader who is long a foreign currency pair can be protected from this of a currency pair falling, while a trader who is short a foreign currency pair can protect against a currency pair increasing.

Traders hedge their currencies primarily through a system known as currency options.

As with options on other types of securities, such as oil or precious metals, foreign currency options give the purchaser the right, but not the obligation, to buy or sell the currency pair at a particular exchange rate at some time in the future. The trader forms an agreement with the dealer to buy a currency at a given price within a limited period. Traders can utilise regular options strategies, such as long straddles, long strangles, and bull or bear spreads, to limit the loss potential of a given trade although some brokers do not allow this, or most other forms of hedging.

Another method of hedging is through spot contracts. These are just like typical trades made by Forex brokers but have a very short-term delivery date (typically two days). Because of this delay however, they are not the most effective currency hedging vehicle and in many cases, regular spot contracts are usually the reason why a hedge is needed.

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