Forex Learning

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.

Out of the many ways to make money online, Forex trade is the fastest track to get the desired amount. All you need to have is an alert brain and taking right steps at the right time. Forex is basically trading for the exchange rate of different currencies. Any type of investment requires safety at certain level. Whether it is stock market investment or real estate investment or the Forex trade, every business has its own risk. Therefore one should always try to play safe. A few guidelines below shall help you to make money on the Forex market.

Choosing the Right Currency: For the advanced and the experienced players the game is safe but for the beginners trading can be risky. While going for your first investment check carefully all the currency values. Choose the one which shall pay you optimized profits, not too much or not too low. Never opt for high profit investments on your first go because you still don’t have enough funds to bear a bigger loss, if it happens.

Choosing the Marginal Value: Setting a marginal value is the most important decision in Forex market. Marginal value is the amount of currency which you set to retain in order to strive through hard times or through times of bigger financial loss. Never spend your marginal value, no matter how much big the temptation be. In most of the cases it is the marginal value which saves people from bankruptcy.

Choosing the Right Firm: While investing for the first time, study the market thoroughly. See the past ten year’s performance of different firms. Compare them judiciously to arrive at the safe conclusion in choosing the most appropriate firm for your first investment.

Risks are everywhere, what we need to do is “investment within the safety limits”.

Money management is the essence of any business. It is the only solution to the times of crisis. Money management policies not only ensure your financial backbone but also help you to survive harsh market conditions. If you are a currency trader and your daily bread depends on the income and gains achieved in the Forex trade then you may not want to loose your whole money on it. Money management is very important to people whose total household income depends on the currency trade. A few money management policies below shall help you to manage your money better and keep your cash inflow high.

Equity Stops: Equity stops helps you decide the percentage of your money you want keep in the risk level. It is the best strategy that provides protection to the newbie from severe financial loss. Equity stop for a newbie is recommended to be kept as low as one percent. The greatest advantage of this policy is that if you suffer from twenty consecutive failures (which are rarely possible) then you have still eighty percent of your equities left with you to survive.

Chart Stops: Chart stop is vey much well suited for mathematicians and traders who are crazy about numbers and probability theorems. They decide the equity stop based on the chart of fluctuations of different currency values with respect to time.

Volatility Stops: Volatility stops are for the advanced players. It takes into account various high profit margin pairs of currencies. This requires a great deal of experience and expertise in this field. Generally this option is best left to the brokers who have a very high understanding of the market.

Margin Stops: Margin stop is the type of the policy in which the trader manually decides the stopping point before he runs out of money.

Your family depends on you and the income gives them their daily bread and shelter, so play wisely and decide cautiously when to stop.