Business

Forex: Hedging and Speculation

Forex

Whenever the business is done outside the domestic market, companies are at risk due to fluctuation in currency values because of buying or selling goods in that manner. In foreign exchange markets, the currency risk is hedged by ensuring that the entire transaction takes place at a fixed rate.

There are various ways to accomplish this. A trader can sell or purchase currencies, either in the swap market or forward market in advance. This kicks in an exchange rate. Take an example of any product like just say a mixer and imagine that a company plans to sell U.S.-made blenders in Europe. Then the exchange rate will be taken into consideration like the exchange rate between the euro and the dollar (EUR/USD) is €1 to $1 at parity.

In the currency futures market, this kind of Hedging can be done. The main advantage is regarding standardization and clearance of future contracts by a central authority.  Nonetheless, currency futures might be less liquid than the forward markets. As the forward markets are decentralized and exist within the interbank system throughout the world.

Forex for Speculation

There are so many interfering factors contributing to the speculation of the forex market. There are things like interest rates, tourism, trade flows, economic strength,  etc which affect the flow of currency. These also handle the supply and demand for currencies, leading to h creation of daily volatility in the forex markets. These changes create opportunities that help in milking profits from the changes that may lead to an increase or decrease in the value of a currency. A prediction that one currency will dwindle is almost the same as speculation that the other currency in the pair will bolster because currencies are traded as pairs. 

If a trader expects rates to increase in America as compared to Australia and their currency exchange rate between the two currencies (AUD/USD) is 0.71 (it takes USD 0.71 to buy AUD 1.00). There will be a strong belief in the trader regarding higher interest rates in the US will eventually increase demand for USD. And,  accordingly, the AUD/USD exchange rate will decline because it will require limited, powerful USD to buy an AUD.

It is important to understand that the fluctuation or any change in the favour produces profit. So, what forex mainly requires is faith and patience. These both will ensure you achieve your long term goal. A deep understanding sure helps anybody in trading. One can initially get started with a broker and keep learning the process.

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