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Forex Market Behaviour – Forex Hedging and Currency Relationships

Forex Traders often focus so hard on finding the ideal forex trading technique that will work on any currency that they often ignore the advantages to be gained by studying currency relationships and hedging opportunities.

As an introduction: the value of a currency is always determined by its comparison to another currency. We call the first currency of a currency pair the “base currency”, and the second currency is called the “quote currency”. The currency pair price shows how much of the quote currency is needed to purchase one unit of the base currency. So when the price of the GBPUSD is 1.5040 it means that the base currency is the GBP and it takes 1.5040 of the quoted currency, the USD, to buy one GBP.

There are a number of forms of hedging available to a forex trader. There are perfect hedges and partial hedges.

An example of a perfect hedge is when you buy and sell the same currency. No matter which way the currency moves you will not make a loss. The problem however is that you will also not make a profit either. Perfect hedges are used in the place of stops when the trader needs some “time out” to reassess a deal. There are advanced forex techniques such as the well known and generally used no stop, hedged, grid system that allows traders to make money buying and selling the same currency all the time due to the currencies habit of revisiting the same price level over an over again.

Another form of a perfect hedge is to use multiple currencies. An example of this is currency relationships that exists between the EURUSD, USDJPY and EURJPY. If you buy the EURUSD and the USDJPY and buy the EURJPY you again create a perfect hedge because no matter which way the EURUSD and the USDJPY move the result will be reflected in the price of the EURJPY. Although you again cannot profit from this, there are traders who that advantage of this in the following way:- when both the EURUSD and the USDJPY are trading in the same direction the movement of the EURJPY is turbo charged and it moves at the total of the EURUSD and USDJPY movement. This extra volatility and direction certainty gives traders of the EURJPY a trading advantage which they capitalise on.

Partial hedges occur when the movement in one currency has a strong potential of offsetting the movement in another. In a US Dollar dominated market the EURUSD and the USDCHF tend to move in opposite directions by the same amount. This means that if a trader identifies possible same direction trading opportunities in the EURUSD and in the USDCHF, this is effectively a straddle or a hedge. This is a popular way of trading as the result is great if the market only activates one of the transactions and not the other. If both are activated there is still a good chance of an overall profitable result.

Other examples of partial hedging in US dollar dominated markets are currency families. US dollar dominated markets are where the weakness or strength of the US dollar is driving related currency prices. Currency families such as EURUSD, GBPUSD, and AUDUSD will all move in the same way – they will all go up or they will all go down. The currency family of USDCHF, USDJPY, and USDCAD will act in the same way. These reasonably predictable family relationships create hedging and straddling opportunities for experienced and skilled traders especially when combined with currency relative strength measurements.

In a nutshell hedging and currency relationship can create great trading opportunities if studied and applied in day to day online forex trading.

Alex du Plooy is a partner and trader at at the online Forex trading company Expert4x.com. He provides articles, videos, free and paid forex course and tools, live trading and training webinars.

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