How to hedge currency prices

Question

Hi guys,

The exchange rates are an important issue to many (esp those going to overseas schools). I am going to attempt a little guide on how to hedge a currency price in theory. But, I have to experience in reality and would urge anyone with such experience come forward and tell me where I'm wrong.

I'm going to start with the GBP/AUD pair because this is the one that impacts me the most (I'm going to LBS from Australia). I have some savings which are equal to a reasonable amount in pounds because of the currently favourable exchange rate.

Step 1. Setup and account with a forex trading service (such as fxcm)

Step 2. Decide the hedge price. For instance the current price of 2.20 (you could wait for the price to come lower but then that would be speculation and not hedging)

Step 3. Remember that in forex trading you don't need 100,000 units to own 100,000 units. Most popular currency pairs can be bought on very high leverage. It turns out that I only need AUD4400 to hedge at the price of 2.20

Step 4. Leave enough margin in the account to protect being stopped out. So for instance GBP/AUD falls to 2.10, my position would lose 10,000 AUD, but my overall savings will be worth more in GBP. So, determine these levels carefully - look for strong support and resistance points. This step is most important, as it will help you determine what is the acceptable price for you to hedge at.

Step 5. Open the position.

ps. don't consider this financial advice - these are just my personal thoughts. I've got ZERO finance education. I'd love to hear feedback from all the gun finance folks in the forum.

89nk · Answer

I am also getting into this. A group of friends have been informing me about this, and some even are looking at creating Matlab programs to help them trade.

I was actually going to start with some books, and familiarize myself with currency trading.

Any advice on how you started? Or did you just surf the web for information? Any positive trading platform?

bsd_lover · Answer

Well I used to trade equities a lot, but I stopped last year (when I finally committed to b-school). I don't actively trade anything at the moment (I just don't have money that I can afford to lose). This is just to create a hedge so that my savings don't go down the drain if the Australian dollar falls. If you're serious about trading, get some books. Here is one that I found useful : https://www.amazon.com/Forex-Patterns-Pr ... R2618RBPMY

prashok · Answer

Thanks for the post, bsd_lover. I was just about to PM you on how to do this, since I need to do the same for USDGBP...

trader1 · Answer

I know bsd_lover is trying to inform and help others out, but I caution anybody who hasn't any clue about forex trading against opening an account with a forex broker and trading on margin.

If you want to hedge a payment stream via a forward contract, check out HiFX.com:

https://www.hifx.com/personal/regular_pa ... rview.aspx

They're my currency broker, and I've used them in the past for several transactions. It has nothing to do with trading. Rather, if you want to hedge a regular payment stream from one currency to another (i.e., pay monthly rent during b-school, etc.), their service is very good. They will quote you a rate, but sometimes you can negotiate with them. It's advisable to first look at the market dynamics of the currency you wish to hedge and determine if you're comfortable with securing that rate (do you think it will keep going up or go down?). Usually, the forward contract rate will be less the current market rate, but HiFX needs to make money to stay in business. I've found the rates to be fair when you are transferring higher amounts per month.

jb32 · Answer

Can't you just open a bank account in London and wire transfer your AUS dollars to that account at the current exchange rate rather than worry about hedging them and keeping them in an AUS bank?

89nk · Answer

I was thinking the same thing, but I guess some people want to make a bang for the buck and "hedge" when their home currency is greater than the currency they are trying to trade to.

I was wanting to actually do currency trading just due to curious interest, but I do not know much about investing, so taking small steps.

Great information Trader.

trader1 · Answer

Banks don't give their customers favorable exchange rates and often there are extra fees associated with wire transfers.

bsd_lover · Answer

as trader1 said - major banks murder you with their spreads. GBP/AUD is an exotic pair - the best spread on a forex trading site I've found is 17 pips. In comparison, A bank would charge me a spread of 500 pips (or 5 cents) and that is a "special rate".

The best provider to do the actual conversion is a service called ozforex which will charge appx 150 pips but this will work best if I do one big conversion at the end. I'm still working and hoping to save a little bit more before I move to London hence I'm loathe to do the conversion right now.

The other reason why people may do this is if they take out a loan in their home country - such as the Stafford loan in the US (which is only accessible to them when they start their course).

How to hedge currency prices

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