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Hedging Range Trades

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Euro Strength Declines As Pound Prepares to Pare Losses (Forex Hedging Strategy)

Thu, Dec 11 2008, 07:36 GMT
by Daily FX Research Team

DailyFX

Since early October both the central banks of the Euro-Zone and the U.K. have aggressively cut interest rates. Mervyn King at the Bank of England, however, has seen himself take a more proactive approach. By slashing rates by an unprecedented 300 basis points during the period, the Bank of England finds its target 50bp lower than that of the European Central Bank’s. The reversed course in interest rate strength now favors that of Trichet and his central bank. With expectations that the isle nation is ready to target whatever rate necessary to end the financial crisis, traders will undoubtedly continue to favor the Euro over the Pound.

For the time being, an opportunity to hedge one’s downside exposure is in the works. A buying trend shows bullish divergence with the RSI oscillator, suggesting the latest two highs have been met with dwindling buying strength. We will look to resistance near record highs at 0.8792 to sell short and support at 0.8488 to exit the trade. Here too, we will look for buying opportunities as the dominant trend regains momentum.

Hedging Strategy

Currency Pair: EURGBP

Long Term Bias: Bullish
Long Term Position: Holding long
Short Term Bias: Bearish
Short Term Position: Sell above 0.8792, Target 0.8488, Stop-Loss at 0.8927

Traders looking to protect their existing long EURGBP position or enter long at a favorable price may consider a hedge long EURGBP above 0.8792 with a target at 0.8488. Once the profit target is hit, we expect the bearish trend to resume. We will maintain a stop-loss on our hedge position should EURGBP break out to the upside prior to the limit being hit. We will set a tight stop-loss near 0.8927, above historic highs.

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, Dec 11 2008, 07:39 GMT