Forex Learning

The efficiency of the Forex business is based on the changing values of the currencies. Therefore the Forex trade is the most unpredictable of all the online business. Success in Forex trade lies in the proper utilization of your technical knowhow and applying the correct strategy at the correct time. A few technical advices below shall help you to decide the flow of your business.

The Technical Part: Before jumping into any kind of major transaction one must clearly understand that there plenty of risks involved. One must have the proper understanding of the marketing scenario and the other factors contributing to the change in the values of the currencies. This change should be very carefully studied and must immediately be jotted down. Over the years the technical analysis shall help to shape your wisdom and decision making process.

The Platform: With a wide scale development of e-commerce there have been many platforms developed to do the trade. While many platforms and software claim to be the best and giving a very promising return, one must always experiment on their authenticity and functionality. The best way to check for the competency of the platform without risking much of your money is through trying a demo account of the platforms.

Keep Caution: The Forex trade may prove to be a failure if we rely upon false signals. One must always remember that no signal is hundred percent efficient. There are often times when people rely on the transient response of the signal which may prove to be very dangerous. Some people invest very heavily during the peak overshoots. While this can be very profitable but at the same time it can make you bankrupt if the non stationary market goes down suddenly in the next moment.

Therefore it is strongly recommended to think carefully rather than depending wholly on a set of predefined algorithms.

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Derivatives can play a key role in mitigating currency risk that arises out of dealing in international trade. The exchange exposure in a Forex trade can be taken care of by using derivatives. Derivatives come in various forms such as Futures, Options, etc. Futures allow a seller and a buyer to hedge their positions. Unlike Options, Futures do not involve payment of an upfront premium, thus becoming a cost effective way for hedging currency risk in Forex Trade.

What are Currency Futures?

Currency Futures are important tools that help in locking-in exchange rate to guard a trader’s position in the Forex Trade in future. One can fix the to and fro of cash flows in one currency with respect to the another by purchasing or selling foreign exchange Futures. Purchasing a foreign exchange Future is known as long hedging while selling it means taking a short hedge position. One of the major limitations of using Currency Futures in hedging is that Futures deal in limited currencies only.

How Currency Futures Work?

Let us understand the working of Currency Futures with the help of an example –

Example: Assume that a German importer promises a U.S exporter payment of Euro 500,000 on 1^st August, 2009. To cover exchange rate risk that the U.S exporter is exposed to, he resorts to selling Futures in Euro now. Suppose the spot rate today is 0.4407 ($/Euro). Expected cash inflow from German exporter on 1^st Aug, 2009 is $220,350 (Euro 500,000 * 0.4407).

The U.S. exporter will sell four September Futures contracts at $/Euro rate of 0.442 that is prevailing in the market. The equivalent notional amount in dollars will be $221,000 (Euro 500,000 * 0.442).

Suppose the dollar appreciates on 1^st August, 2009 and the spot exchange rate becomes 0.43908. The equivalent amount in dollars will be $219,540 (Euro 500,000 * 0.43908). Loss on spot position will be $810 ($220,350-$219,540).

At the Forex trade scenario, the situation will be as follows. Buy four September Euro Futures contract at the rate of 0.44038. The exporter will have the notional right to buy Euro 500,000 by making a payment of $220,190 (Euro 500,000 * 0.44038). In this case, Profit = $810 ($221,000-$220,190).

Hence, we can observe that the loss arising from the spot market is covered by dealing in Futures market.

Liberalization of norms on international trade has played a role of a catalyst in the economic growth of several countries. With international trade is in its boom period, the cash registers are rolling for many economies. Though liberalization is the order of the day, it has brought with it new complexities and risks that makes Forex trade a challenging task. Countries all across the globe are taking steps to minimize the foreign exchange risk to its minimum.

Foreign exchange risk is the risk that is involved when one is dealing with foreign currency, whose value keeps fluctuating with time. This fluctuation in the valuation of the foreign currency is known as foreign exchange risk. Exchange rate fluctuations can turn profitable business deals into losses. Following instruments can help you cover foreign exchange risk.

Popular Hedging Tools

• Forward Contracts: Forward contract is a contract between a buyer and seller about an underlying asset at a predetermined price, quantity and date. These contracts are flexible in nature since its terms can be changed upon the mutual consent of both the parties. However, one of the major limitations of a forward contract is that there is no established market to trade them which makes them relatively less liquid.
• Futures Contracts: Futures Contracts are the liquid forms of Forward Contracts as there are established markets to trade them. Futures contracts are bought and sold in an open market, just like shares.
• Option Contracts: An Option Contract is different from a Forwards or Futures Contract. In an Option contract, the buyer/seller of the Option has a right to buy/sell an underlying asset at a predetermined date, quantity and price, in exchange of a premium. Options are of two types – Call Options and Put Options.

One of the advantages of Options over Forward and Futures Contracts is that in case of Options, the risk to be borne by a party is limited to the extent of the premium. One can deal in the above mentioned Hedging Tools to cover foreign currency risk.