What is Forex Hedging? Hedge Definition

Forex Hedging Definition, hedge on forex

Forex Hedging

– In fact, “Forex Hedging” is the name given to the solution of a problem that arises during international trade. If your company works with other companies and work with different currencies, you would be directly affected by the currency exchange rate changes and this can cause unstable businesses. You cannot make accurate plans for buying materials or your revenues. Luckily there is a way to avoid this kind of problems with the forex: Forex Hedging … You can read about it in this article below.

Risk management is one of the essential concepts of the business world. Each profession or sector has a variety of risks, and it is vital to anticipate them in order to reduce your losses. We recommend you to read the information about the risks in the Forex market on our website. Although risk management, in general, is a separate specialty, you can obtain the basic knowledge you need about the risk management of your forex business here. Knowing how to take the precautions against the risks in this market will protect you from the significant losses. One of these precautions is the “hedging”.

What is forex hedging?

In forex, you can freeze exchange rates for your transactions. This fixing method is called “doing a hedge”. To do a hedge, you need to do some beforehand currency trading in “forward market” or “swap market”. In “forward market” and “swap market” exchange rates are fixed. We will explain to you them later. Now, let’s take a look at an example of the problem you can experience;

Forex Hedging: Business Overseas

Let’s say you manufacturing a product in the U.S. and you are planning to sell it in Europe. Assume that you are doing your business while USD/EUR pair is 1:1, for the example purposes. If the cost of making the product is $100 USD and you sell it for the average acceptable price of €150 EUR in Europe, your profit would be $50 with that rate. But if the value of USD increases and the cost of buying a euro decreases to $0.65, you would have a serious problem.

Even though you are a US-based manufacturer, a stronger USD would harm your profit. With this new rate, your selling price, €150 would come back to you as $97.5 ($150×0.65), lower than your manufacturing cost! Of course, a drop to 0.65 from 1.0 would be almost impossible in real cases, but with all the additional transport costs and taxes you wouldn’t want even the smallest exchange cuts from your $50 profits. When all add up, this can ruin your business plans.

Here is Forex Hedging

What you can do to avoid problems like this is to short the euro and buy the dollars while at parity. So, with this investment, you can balance the decrease in your profit from product sales with your profit in forex. This is how the strategy we suggested in the beginning, beforehand currency trading in “forward market” or “swap market”, will help you.

Of course, there is also a chance for USD to lose some value. In this case, your product sales profit would be higher and balance your forfeit in the forex. But, if you don’t need that forex investment money back right away, you can also keep it as euros, and wait for it to become profitable to buy USD again. So, you can increase your profit even more.

Conclusion

So, “Forex Hedging“, a term that is quite confusing for some, is actually as simple as we explained above. But in the Forex Hedging, everything depends on the changes in the exchanges rates. And, as you can imagine, there a lot of factors that can affect exchanges rates that we talked about, here, in forex hedging. So, you need to learn more about them.

The supply and demand balance between currencies is shifting continuously by countries’ economic strength, tourism, critical news, geopolitical risks, interest rates, trade flows, and many other factors. You can read about these factors and the opportunities you can use with them in our article about “Forex Speculation“.

Now, you should have learned the hedge definition and a beginning level information about Forex Hedging. For more detailed explanations on hedging on Forex Market, you can check the links on this page for this website or other related websites.

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