Day Trading Forex

When it comes to investment, hedging is not a strange word. Though many of you have already heard of the name hedging, not many of you may be able to explain what hedging is. Without the ability to explain the term, I guess you have not yet participated in the hedging world, which actually can be useful to protect yourself. Let us now understand it.

Why there are so many people and well established enterprises use hedging? You need opportunities from investments. But no free lunch, there are risks linked to such investments. To reduce the risks on such investments, many of them choose hedging as one of the methods. There are many different types of hedging products available to cover different types of investments. You can find foreign currency ones, interest rate ones, future ones, options ones and stock price ones.

You have to remember the golden rule that hedging is not a way to help you earn more money. It is a tool to help you reduce the risk. By that, you will invest in two different products that are negatively correlated. The risk is reduced by the offset between the gain and the loss from each of the investment. Or, when investment A is in a gain position, investment is on the contrary a loss position. The gain offsets the loss.

As you see from the case of investment A and B, you will know that the risk of losing money from investment B is hedged by the gain in investment A. On the other hand, you can think that the gain in investment A is unluckily reduced by the loss in investment B. It is true that the possible earning from the total investment portfolio can be lower is the risk is hedged. It makes sense as the lower the risk, the lower should be the opportunity and earning.

To illustrate more clearly, we can now assume a case with interest rate swap. Assume that you have borrowed a $60,000 loan from a bank. No doubt, the bank will charge you interest say at LIBOR + 2%. As an interest payer, you must be concerned that the interest rate may increase. Therefore, you enter into an interest rate swap with the bank to receive a floating interest income at LIBOR + 2%.

When it comes to such hedging instrument, you have a choice to decide if you want to fully hedge or partly hedge. You can enter into a $30,000 hedge or a full hedge of $60,000. Why you want to do so? It is because there is tradeoff between you risks and opportunities. For simple explanation, I assume you have entered into a $60,000 hedge that you receive interest income.

When the interest rate increases, you have to pay more interest for your loan, but you receive more interest income on the other hand. If interest rate decreases, you can pay less interest for your loan, but your interest income also decreases. For explanation, hedging can be simple. But in real case, you may not find the hedging is such a perfect hedge that all your risks can be completely eliminated.

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Many of you like investing in different kinds of investments. One type of investment that you may have is foreign exchange or foreign currency trading. Do you always win the game? Or are you losing money on that? You are not a sheep that simply follow what others do. You need to setup you own foundation on currencies before you can gain your money!

In fact, currency fluctuation can be affected by a number of factors. In the broadest sense, a country’s economic situation and its macroeconomics decisions have the greatest effect on its currency fluctuation. That is why you find the analysts are really familiar with such economical statistics, news and information. Common indices that you should be aware of include Gross National Product 9GNP), interest rates and consumer price index, etc. With the grasp of such information can help you make wise decisions in the forex trading market.

The national income and expenses from foreign economic activities is the first thing to look at. You may simply regard the foreign import and export as an indication of such information. When the foreign import is greater than the foreign export (or the foreign expenses are greater than the foreign income), a trade deficit is result. Trade deficit shows the demand of foreign currency instead of local currency. With the increase in demand in foreign currency, the foreign currency is going to appreciate. It is simply like every woman wants diamond, therefore, the diamond price goes up.

Other than the foreign income and expense, you can also look at the national income. National income means the people’s income in the nation. The fact is that, when people are earning more, they are likely to spend more. When they spend more, the demand of local currency increases. Like what we have talked above, the demand of the local currency drives the appreciation of it.

To be carefully, by solely looking at the increase or decrease in national income can sometimes be misleading. You need to drill down to the real factor that causes the increase or decrease in national income. For example, an increase is caused by governmental policies or demands and such policies may require significant foreign imports (additional to the local supply), then the foreign currencies are likely to appreciate even the nation income increases.

Inflation is also worthwhile to look at for forex trading. Inflation usually takes place when there is excessive free cash (local currency). By excessive I mean the currency or money issued is greater than the consumption on product purchase. When inflation takes place, the product price goes up. When the product price goes up, people tend to buy less. When people buy less, the demand of the local currency decreases. The decrease in demand of local currency in turn cause it to depreciate.

Foreign income and expenses, National Income and inflation are the most fundamental and important to understand for forex investments. Of course, there are many other important factors out there. Do explore more before you actually make any big decision!

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