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Hedging Range Trades

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New Zealand Dollar to Rise With Risk Appetite, Challenging Long−Term Bears (Forex Hedging Strategy)

Mon, Nov 10 2008, 08:41 GMT
by Ilya Spivak

DailyFX

Since the collapse of Lehman Brothers in mid-September, risk sentiment has driven investors away from risky assets and into U.S. Dollar denominated money markets. As such, Dollar demand enjoyed sharp upside moves as overnight interest rates exhibited uncomfortable highs. However, over the past seven days these rates have fallen dramatically. Aggressive liquidity-boosting measures by the world’s top central banks have thus far paid off. Price action since has seen greenback demand give up some gains against currencies like the New Zealand Dollar for the time being. Kiwi strength may continue against its U.S. counterpart for the near-term as risk aversion takes a back seat. The long-term, however, will probably see greater action on the part of the Reserve Bank of New Zealand to side-step the global recession. With larger rate cuts coming from the RBA, overall strength may favor the greenback.

For the time being, an opportunity to hedge one’s upside exposure is in the works. A bearish channel shows divergence with the RSI oscillator and has yielded a bullish breakout above the 23.6% Fib at 0.5905, an appropriate point at which to buy the pair. We will look to resistance at 0.6267, the intersection of the 38.2% Fibonacci retracement of the 07/16-10/27 selloff and a multi-month downward sloping trend-line, to exit the trade. Here too, we will look for selling opportunities as the dominant trend regains momentum.

Hedging Strategy

Currency Pair: NZDUSD

Long Term Bias: Bearish
Long Term Position: Holding short
Short Term Bias: Bullish
Short Term Position: Buy above 0.5905, Target 0.6259, Stop-Loss at 0.5734

Traders looking to protect their existing short NZDUSD position or enter short at a favorable price may consider a hedge long NZDUSD above 0.5905 with a target at 0.6259. Once the profit target is hit, we expect the bearish trend to resume. We will maintain a stop-loss on our hedge position should NZDUSD break out to the downside prior to the limit being hit. We will set the stop-loss near 0.5734.

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  Mon, Nov 10 2008, 08:45 GMT