Market volatility can be a blessing and a curse, depending on the perspective of an investor. While volatility is what creates opportunities on the market, it also leads to investors losing billions of dollars every year.
The forex market can be particularly volatile, as major economic developments hit the currency markets first and foremost.
For this reason, investors have been looking for ways to hedge against market volatility for decades – to varying degrees of success.
As a forex investor, you may also be wondering about the tools and software that can help you with hedging against excess risk.
Luckily, the trading platforms you are using can also provide you with the ability to hedge against your current holdings to mitigate risk and go through market volatility with very little losses, if any.
How to hedge against a volatile forex market
When the global FX markets are in disarray, chances are that major economic events are taking place. For example, some of the largest exporters of value added products could be experiencing an economic downturn, which can weaken their respective currencies and, thus, affect every single FX pair the currency is a part of.
Hedging against such risks can be done using your primary piece of trading software, such as the MetaTrader 5 or cTrader.
Your trading platform is not limited to simple buying and selling currencies. You can also buy and sell a wide range of derivatives, such as forward contracts, options, futures, swaps, and more.
Using MetaTrader 5 to hedge against FX risks
To better understand how to use MT5 to hedge against currency risk, let’s look at an example of the JPY/USD pair.
If we assume that there is an expectation that the Japanese yen may weaken against the U.S. dollar in the future, the current spot rate is 110 and we need to hedge against JPY 100 million using options contracts.
If we assume that the premium is $10,000 and we buy call options with a strike price of 112, we can theorize the following scenario:
- The rate moves to 115, meaning that the JPY 100 million now buys less USD
- Since the strike price of the option is 112, we are able to exercise the option and receive more USD
This way, we are able to hedge against the volatility of JPY 100 million by using $10,000, which allows us to hedge against more than $20,000 in losses that would occur without the option.
The MetaTrader options board gives traders the capability to execute such trades and hedge against the volatility of any currency that is available for trading on the platform.
However, it is worth noting that MetaTrader is far from the only trading platform that allows hedging using options and futures contracts and cTrader is a popular alternative, among others.
How effective is hedging in trading?
The effectiveness of forex hedging strategies depends on the specific derivatives a trader intends to buy and the specific instruments they are hedging against.
Major currencies usually have a lot of options for hedging and options contracts on the likes of the Japanese yen and the U.S. dollar are easily accessible to traders.
Using options for hedging, as well as other derivatives, also carries some risk, as it is near impossible to consistently guess the direction of a particular currency.
For example, if a trader buys call options to hedge against a pair and the price decreases, the options strategy will be counterproductive.
Hedging using the Bloomberg Terminal and Refinitiv Eikon
The Bloomberg Terminal and the Refinitiv Eikon are two of the most sophisticated pieces of software used by institutional traders that come with a wide range of features and access to thousands of instruments on the market.
The process of hedging is similar to any other software that allows traders to access derivatives on forex and other instruments. Where the Terminal and Eikon stand out is the superior customer support and technical features that support large amounts of data and technical indicators, as well as high-complexity trading strategies.
However, such pieces of software are quite costly and accessible to institutional market participants, as opposed to retail forex traders.
Overall, hedging options using software are available to both institutions and individual traders who have the risk appetite required to trade derivatives.
institutions and individual traders who have the risk appetite required to trade derivatives.
