The Four Benefits Of Hedging

Discussion in 'General Trading Discussion' started by Adam Smith, Nov 23, 2016.

  1. Adam Smith

    Adam Smith Active Member

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    Hedging is a tool which is generally used by a huge number of traders in order to avoid losses in the foreign exchange or stock market. This is done chiefly by diversifying the investment portfolio of a particular trader. It’s not something which is recommended for newbies, but nevertheless it is a widely used mechanism. In order to exercise a better grasp of the benefits of hedging, you should have a look at some of the points taken from the www.easymarkets.com :

    1. All Long-term Risk can be Eliminated

    In case you are based out of Britain and trade on the currency pair of the US Dollar and the Pound, then you would naturally want to buy off the shares and stocks of all the companies in the UK. Thus, your trade would become greatly dependent upon the prevailing rate of exchange between the US Dollar and the UK Pound. However, this exchange rate will constantly undergo alterations over time owing to the different economic-political developments that are bound to take place. Because of this, there is a need to hedge the currency risks to gain in the long term.

    2. You Will Be Able to Diversify your Portfolio

    As has already been specified at the outset, the main objective of hedging is to diversify your portfolio. In case the investors happen to find emerging markets attractive, they wish to put more at risk and achieve higher returns. Since a majority of investors make use of investments which are based in foreign, they drastically reduce their exposure to risk, thereby using currency-hedged mutual funds.


    3. You Get to Hedge by Using Forward Contracts

    A great number of exchange-traded funds make use of forward contracts so that they can hedge currency risks. These contracts can be bought by all the major world currencies that exist. A forward contract (also known as the currency forward), helps the purchaser to determine the price which needs to be paid for a particular currency. This means that the exchange rate would be completely frozen in place for a definite period of time.

    But the purchasing of forward contracts generally can be had for a price. The contract functions as protection towards the value, if exchange rates were to shift against the value of the currency. To use the United Kingdom’s example, a forward contract chiefly serves as protection to an investor when the pound’s value is on the plunge in relation to the dollar. And if the pound were to be enhanced in value, the forward contract would not be required.

    Funds which make use of currency hedging have the belief that the cost of hedging would pay off in the long-term. The fund's chief aim is to reduce the risk associated with the currency and accept the additional cost of purchasing forward contracts.

    4. Hedging Large Currency Declines

    A currency hedging strategy would be of huge use to the investor if the currency value were to see a sharp fall. Political and economic factors would be able to cause huge fluctuations in the rates of exchange. Currency rates can be extremely volatile in certain cases. A hedged portfolio is more costly, but it would protect your investment if the value of the currency were to see a sharp decline.

    In short, these are the benefits that a trader gets out of hedging their currency options
     
  2. JR Ewing

    JR Ewing Super Moderator Staff Member

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    Good article. I like to occasionally buy a cheaper currency and use that currency to buy commodities. I also like to use puts and calls to hedge and speculate.
     
  3. longtermbull

    longtermbull Administrator Staff Member

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    The idea of hedging your downside but leaving your upside open attracts me. In the past I have used options to hedge with synthetic call and put options on stocks. If you time these right they can be extremely lucrative.
     

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