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Hedging Range Trades

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US Dollar To Correct Strength Against Canadian Counterpart (Forex Hedging Strategy)

Tue, Sep 9 2008, 11:08 GMT
by Ilya Spivak

FXCM

After a 9-month decline in 2007, USDCAD has seen itself come back from a low that nearly broke the .90 mark. The remarkable 10-month rebound came on fears that the slowing US economy would bring Canada’s export driven growth to a halt. But now a new reason to rejoice in the Dollar bull-run has priced its way into the Dollar-Loonie pair. As the end of Fed interest rate cuts began being forecasted only one alternative to FOMC policy became plausible – rate increases. Now, with GDP revisions yielding a 3.3% annualized growth rate through the second quarter for the US economy, it seems nothing may stop the Dollar run. Case in point, USDCAD did virtually nothing last week as the US Unemployment Rate jumped up 0.4 percentage points to 6.1% for August. US inflation ticked to 5.6% through the end of July, with analysts predicting rate increases of up to 100 basis points through the end of 2009. Meanwhile, the Bank of Canada may cut rates one more time in the beginning of 2009 as annualized GDP growth increased a meager 0.3% in the second quarter and was revised to a decline of -0.8% in the three months to April. All in all, pressure to kill inflation will dominate the Fed’s agenda throughout 2009 while the BOC will work to check the slide in economic growth.

With the overall economic perspective in favor of the greenback, the technical outlook opens the door for a short-term retracement downward. After oscillating in an ascending wedge since Q3 of 2007, USDCAD has found significant resistance at the 61.8% Fibonacci retracement from the 02/09/07-11/09/07 sell-off. One may also notice that in the weeks preceding the September 2007 down swing, the pair was testing the same technical level. Prior to continuing the upward theme, a forthcoming correction downward would target support at 1.0454 (50.0% Fib level). The stochastic oscillator is reversing from overbought territory, suggesting a near-term top is approaching.

Hedging Strategy

Currency Pair: USDCAD

Long Term Bias: Bullish
Long Term Position: Holding Long

Short Term Bias: Bearish
Short Term Position: Sell above 1.0790, Target 1.0454, Stop-Loss at 1.0930

Traders looking to protect their existing long USDCAD position or enter long at a favorable price may consider a hedge short USDCAD above 1.0790 with a target at 1.0454. Once the profit target is hit, we expect the bullish trend to resume. We will maintain a stop-loss on our hedge position should USDCAD break out to the upside prior to the limit being hit. We will set the stop-loss near 1.0930.

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.

Published on  Fri, Sep 26 2008, 09:19 GMT