Before discussing what a forex hedge is, we will briefly look at what forex trading is and why people do it.

Forex is an abbreviation for ‘foreign exchange’, in other words foreign currencies. What a forex trader therefore do is to buy and sell foreign currencies. Like anyone else trading in any other commodity, he hopes to make a profit from these transactions.

Most of us understand the concept of buying something of which you hope the price will rise in future and then selling it at a profit later. This is an age old way of making money and the currency market is no different from other markets in this respect.

Many people find it more difficult to understand how you can make money by selling something you don’t have. This is not so strange, however. If you expect the price of the Euro to drop in future, you could for example sign a contract with someone to deliver a certain amount of Euros to him three months from now at the current price. When the time comes and the price has dropped, you buy the Euros on the open market, deliver it to your business partner and get paid the old, higher price. So you’ve made money by selling something you did not have at the time.

There is another reason for doing this as well. Let’s suppose you already have Euros. And you are sure the price will drop over the coming months. Then you can sell them with a forward contract like above to someone else at today’s prices, but with a future delivery date. So you will still get the higher price even if the price a couple of months down the line is much lower.

This is called hedging. A forex hedge is therefore simply selling a currency (or going short in trading lingo) to protect your current investment in that currency.

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