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The investment community uses “hedging” to describe protecting or lowering your risk of loss on a trade. There are a few tools you can use to hedge your risk in the foreign exchange and currency transfer market: forward contracts, limit orders and stop-loss orders.
Forex transactions can be completed in two ways: by using a spot contract or using a forward contract.
A spot contract is just that — a rate that a bank or money transfer service quotes on the spot at the moment of your exchange. If you’re sending a one-off transfer, you’re using a spot contract. The rate you’re offered is often a margin above the interbank or mid-market rate, marked up a bit so the provider can pocket the difference. You’ll typically get a better spot contract with an independent money transfer service than you will with a bank.
Unlike a spot contract, a forward contract allows you to lock in a favourable exchange rate for future purchases, protecting you against unexpected fluctuations in exchange rates. Ideal for businesses or those making recurring transfers, these agreements usually guarantee you a rate from 30 days to up to two years. They typically require a deposit with the balance due once the contract is executed.
Exchange rates constantly fluctuate, and most foreign exchange providers offer order services that smooth out the predictability of these fluctuations. Order options are best for those who have a good handle on predictions and know when it’s a good time to buy.
With a limit order, you specify your ideal exchange rate. When the market reaches that rate, it’s locked in and you’re contacted to authorise the completion of your transfer.
A stop-loss order is nearly the opposite of a limit order: instead of specifying an ideal rate, you indicate a rate you want to avoid dropping below. If the market falls to that rate, your currency is purchased automatically, giving you the potential to profit when the market rises again. Many people use limit orders and stop-loss orders together.
If you need to send regular transfers overseas — weekly, monthly or quarterly payments to the same recipient — many services will allow you to lock in even better rates with lower fees.
As with any money transfer transaction, be sure to compare your options so you can get the best rates and fees for your money.
To begin hedging your forex trades, you’ll need to:
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