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Hedging Range Trades

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New Zealand Dollar to Retrace Before Down Trend Continues (Forex Hedging Strategy)

Fri, Nov 21 2008, 07:28 GMT
by Daily FX Research Team

DailyFX

It is no surprise that the New Zealand Dollar continues to slide against its U.S. counterpart as RBNZ members have slashed rates by 175bp over the course of its last three consecutive meetings. The latter meeting alone saw an unprecedented 100bp cut. Following the decision came a 12.5% loss in the kiwi in the three days following the decision. With the current overnight cash rate at 6.50% the bank has substantial enough room for further action. The U.S. on the other hand has the benchmark Federal Funds rate at 1.0%, with little room to play. Albeit recent Fed minutes have revealed an FOMC full of anxious policymakers willing to cut rates to 50-year lows, the fact remains that the RBNZ has well over 550bp before breaching current Fed territory. Of course, this also implies that the Reserve Bank of New Zealand has further currency devaluating capability that may likely be used if it wishes to stave off the impact of the global recession on its domestic economy.

With the overall economic perspective in favor of the greenback, the technical outlook opens the door for a short-term retracement upward. After oscillating in a clean descending corridor since early October, NZDUSD is on the verge of finding downward channel support along the 138.2% Fib. extension of the 06/29/06-07/24/07 rally. Furthermore the pair appears to show bearish divergence with the RSI oscillator and may yield a bullish breakout above 0.5100. We will look to resistance at 0.5616, the intersection of the 114.6% Fibonacci retracement and the upper channel 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 0.5100, Target 0.5616, Stop-Loss at 0.4843

Traders looking to protect their existing short NZDUSD position or enter short at a favorable price may consider a hedge long NZDUSD above 0.100 with a target at 0.5616. 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 a tight stop-loss near 0.4843, at 150% Fib. extended retracement.

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  Fri, Nov 21 2008, 07:56 GMT