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Hedging Range Trades

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Hedge Offers Cover as GBPCAD Retracement Favors Downside

Thu, Jul 3 2008, 05:56 GMT
by Ilya Spivak

DailyFX

Historically, oil prices have moved in lock-step with the Canadian dollar. However, the relationship has seen a sharp divergence in recent months as the CAD failed to capitalize on the rally in crude prices because of the fallout from US slowdown on the Canadian economy. With nearly 80% of exports headed to the US, the fate of Canada’s economy is irrevocably locked to that of its Southern neighbor. Meanwhile, the Pound has seen a return to strength as the growing concern over inflationary risks in the UK continues to pressure the Bank of England to raise borrowing costs.

GBPCAD price action has oscillated in a well-defined upward corridor since May. Current positioning sees the pair approaching resistance, with a potential cyclical downturn to follow. The stochastic oscillator is above the key 80 level, hinting that the pair is overbought and lending credence to a downward retracement scenario.

Hedging Strategy

Currency Pair: GBPCAD

Long Term Bias: Bullish
Long Term Position: Holding Long

Short Term Bias: Bearish
Short Term Position: Short below 2.0445, Target 2.0061, Stop-Loss at 2.0563

Traders looking to protect their existing long GBPCAD position or enter long at a favorable price may consider a hedge short GBPCAD below 2.0445 with a target at 2.0061. Once the profit target is hit, we expect the bullish trend to resume. We will maintain a stop-loss on our hedge position should GBPCAD break out to the upside prior to the limit being hit. We will set the stop-loss near 2.0563.

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  Thu, Jul 3 2008, 05:58 GMT