Reasons For Using A Forex Hedge:
filed in Forex Hedge on Mar.26, 2010
Before we discuss what is meant by a forex hedge, we will take a brief look at what forex trading involves and why traders do it.
Forex is simply short for foreign exchange. This in other words refer to foreign currencies. A forex trader is thus someone who buys and sells foreign currencies. As with other traders in different types of commodities, he hopes that at the end of the day he will make a profit from doing this.
The majority of us understand the concept of buying a product now if you expect the price to increase in future and then selling it at profit somewhere down the line. This way of making money is nearly as old as humanity itself and the currency markets don’t function different from other markets in this respect.
What many people seem to find difficult to comprehend is when you sell something which you don’t have to make money in future. This is not as strange as it sounds. Let’s say you expect the price of the Yen to drop drastically over the next three months. What you do now is to find a buyer for a certain amount of Yen at today’s prices, but for delivery three months from now. After 3 months you buy that amount of Yen on the open market at the lower price, deliver it to the buyer and he has to pay you to old (higher) price which you agreed on.
This is one reason for ‘going short’ on a currency. Another reason is when you already have that currency and you expect the price to drop. As in the above example, you can find a buyer who agrees to buy it from you at today’s prices for delivery somewhere in the future. If the price actually drops, you haven’t lost anything because he still must pay you at today’s prices. This is hedging – you protect your current assets against possible price drops.
A forex hedge is thus not as involved as it sounds. It is simply a way of protecting an investment you might have in that currency against possible price drops in the future.