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Hedging Range Trades

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Hedge To Protect Pound Bulls As NZ Dollar Retraces Losses

Tue, Aug 12 2008, 06:23 GMT
by Ilya Spivak

DailyFX

Possibly the only country other than the UK forecasting a worse fate for its domestic economy is New Zealand. Thursday’s jobs report continued to provide evidence of a pessimistic future for the South Pacific economy as their unemployment rate rose for the 2nd straight quarter to 3.9 percent from 3.4 percent at the end of 2007. On the contrary the UK’s unemployment rate has been relatively stable through the same period, remaining at 5.20% with only one uptick to 5.30% in April. Reserve Bank of New Zealand Governor Alan Bollard has explicitly signaled further rate cuts this year while the Bank of England is timid about easing borrowing costs. Minutes from July’s BOE meeting reveal an ongoing struggle to define which macroeconomic condition is of greater priority, inflation or economic growth. We know that “for all members of the Committee, the decision was a difficult one.” With such an ambiguous outlook for monetary policy, Governor Mervyn King and company have left economists forecasting little or no rate action this year. We will see the UK-NZ yield gap dwindle to 125bp if private forecasts estimating rate cuts of up to 200bp are indeed in line with Mr. Bollard’s plans. All told, the underlying fundamentals are firmly in line with GBPNZD strength.

While the broad economic backdrop favoring the Sterling, the technical outlook opens the door for a short-term retracement downward. GBPNZD price action has been oscillating in a clean ascending channel since the middle of May. A forthcoming retracement downward would target support at 2.6556, the channel’s lower boundary. The stochastic oscillator has flattened in over-purchased territory, hinting the pair has exhausted buying pressure and lending credence to the likelihood of a corrective pullback in the near term.

Hedging Strategy

Currency Pair: GBPNZD

Long Term Bias: Bullish
Long Term Position: Holding Long
Short Term Bias: Bearish
Short Term Position: Sell between 2.7380-2.7410, Target 2.6556, Stop-Loss at 2.7864

Traders looking to protect their existing long GBPNZD position or enter long at a favorable price may consider a hedge short GBPNZD between 2.7380-2.7410 with a target at 2.6556. Once the profit target is hit, we expect the bullish trend to resume. We will maintain a stop-loss on our hedge position should GBPNZD break out to the upside prior to the target being hit. We will set the stop-loss near 2.7864.

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  Tue, Aug 12 2008, 06:27 GMT