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Hedging Range Trades

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Hedging EURJPY Retracement Offers Entry to Yield−Driven Rally

Fri, Jun 20 2008, 09:07 GMT
by Ilya Spivak

DailyFX

Inflation worries have kept the European Central Bank hawkish, with President Jean-Claude Trichet hinting that a rate hike may imminent in the near term. Executive Board member Lorenzo Bini Smaghi echoed the sentiment, saying that a quarter-point hike should be enough to bring Euro Zone inflation back below the target 2%. Meanwhile, minutes released from the Bank of Japan’s policy meetings in April and May further cemented the bank’s neutral stance as they balance competing forces from global inflationary trends with floundering domestic growth. Expectations of a widening interest rate differential have taken the Euro to 15-year highs against the Yen.

With interest rate expectations firmly in favor of a bullish bias, the technical outlook opens the door for a short-term retracement lower. EURJPY price action has oscillated in a well-defined corridor since March. With the pair approaching relevant resistance, a cyclical downturn may ensue. The stochastic oscillator is above the significant 80 level, hinting the pair is overbought and lending credence to a forthcoming retracement.

Hedging Strategy

Currency Pair: EURJPY

Long Term Bias: Bullish
Long Term Position: Holding Long

Short Term Bias: Bearish
Short Term Position: Short below 168.40, Target 163.61, Stop-Loss at 169.77

Traders looking to protect their existing long EURJPY position or enter long at a favorable price may consider a hedge short EURJPY below 168.40 with a target at 163.61. Once the profit target is hit, we expect the bullish trend to resume. We will maintain a stop-loss on our hedge position should EURJPY break out to the upside prior to the limit being hit. We will set the stop-loss near 169.77.

When should I use the hedging feature?

Markets hardly ever trade in the same direction for long. Though there are general trends that may unfold for weeks, months and years; there is almost always considerable fluctuation in price during these periods – sometimes leading to significant retracements. There are a few common strategies that traders use to immunize their risk to counter-trend moves while still holding to the long-term trend. One method of reacting to these changing tides is to actively enter and exit a trade on each swing, which requires constant attention and a superior ability to pick tops and bottoms. The other, more passive, strategy is to hold on for the long-term trend through retracements in the belief that the higher trend will reengage. Taking a temporary hedge positions through the counter-trend moves, on the other hand, requires less accuracy in picking tops and bottoms and at the same time lowers the drawdown while increasing the potential for return.

The hedging feature is currently available on all accounts using FXCM’s No Dealing Desk service.

For more information on FXCM hedging strategies please visit http://www.fxcm.com/hedging.jsp.

Published on  Fri, Jun 20 2008, 09:10 GMT