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Hedging Range Trades

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British Pound to Rise Against Japanese Yen Before Down Trend Resumes (Forex Hedging Strategy)

Thu, Nov 13 2008, 07:59 GMT
by Daily FX Research Team

DailyFX

Since early October the Bank of England has shown little shyness in its pursuit to ease liquidity concerns; it has cut its benchmark interest rate by 200bp over the course of the four weeks ending November 6. In its Quarterly Inflation Report, the bank revised its growth and inflation forecasts substantially lower. Meanwhile, the Bank of Japan has been limited to a single rate cut of a magnitude 20bp. With such an outlook showing little optimism for the UK economy, Mervyn King has been forced to signal more aggressive action on the part the bank. With rate expectations strongly favoring continued Sterling deterioration, the Yen may continue rallying as the fundamental forecasts become realized.

For the time being, an opportunity to hedge one’s upside exposure is in the works. A selling trend shows bearish divergence with the RSI oscillator and has yielded a bullish breakout near 13-year lows at 1.4170, an appropriate point at which to buy the pair. We will look to resistance at 152.45, the intersection of the 23.6% Fibonacci retracement of the 09/25-10/24 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: GBPJPY

Long Term Bias: Bearish
Long Term Position: Holding short
Short Term Bias: Bullish
Short Term Position: Buy above 141.70, Target 152.45, Stop-Loss at 137.38

Traders looking to protect their existing short GBPJPY position or enter short at a favorable price may consider a hedge long GBPJPY above 141.70 with a target at 152.45. Once the profit target is hit, we expect the bearish trend to resume. We will maintain a stop-loss on our hedge position should GBPJPY break out to the downside prior to the limit being hit. We will set a tight stop-loss near 137.38 as such a level would break 13-year lows.

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, Nov 13 2008, 08:02 GMT