Beware of Currency Hedgers
15 Years ago | October 28, 2014 12/11/23, 12:00 AM
After an extended period of low volatility the forex market has seen activity pick up and daily ranges widen. This has come as a relief to many as it has opened up opportunities to trade. For many retail traders, they treat the market the same no matter how conditions change. I feel it is important to understand the dynamics of the market so you can adjust when conditions change as I will explain in this article.
When the forex market was stuck in the period of low volatility, there was no incentive for those with currency exposures to hedge their risk. Before I go on, I need to differentiate between a retail forex platform hedge and a real hedge. Retail forex traders can “hedge” positions by buying (or selling) in a like amount to an open position. This is not a hedge in the true sense but either an excuse to not book a loss (most times) or to temporarily book a profit. I address this in I Hate Forex Hedging and So Should You and suggest reading it.
A real currency hedge, as I refer to it, is when someone looks to protect an open fx position (e.g. via stocks, bonds, etc) by either buying an option, buying or selling the opposite of the open position forward in the interbank market or by buying or selling another currency against it. What these hedging strategies have in common is that they all involve some degree of cost or risk.
When the forex market is in a period of low volatility or ranges, there is not a strong incentive to hedge currency risk. On the other hand, when there is a pickup in volatility and currency risk, investors, etc. look to hedge currency exposures. This, in turn, increases the volatility in the forex market, can accelerates trends and makes it more than just a speculators market due to real money flows by those looking to hedge their currency risk.
So keep this in mind when markets move from one extreme (e.g. low volatility to high volatility or vice versa, trend reversal) as “real hedging” plays a role in exacerbating a trend until the flows slow down. Of course there are other factors that influence the forex market but this is one aspect that many do not pay attention to and they should, especially those many retail traders who seem to prefer fading moves than jumping on a trend.
Jay Meisler, founder
Global Traders Association
