How to “lock-in” an exchange rate for your money transfer with hedging options
Save on your international money transfer or forex trade with a temporary, guaranteed rate.
Hedging options like forward contracts can help you lock in strong rates when exchanging currencies. Let’s bust some jargon!
What does it mean to “hedge” your options?
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.
Contract options
Forex transactions are generally carried out in 1 of 2 ways: by using a “spot contract” or by using a “forward contract”.
Spot contracts
A spot contract is a rate that a bank or money transfer service quotes on the spot at the moment of your request. If you’re sending a one-off transfer straightaway, you’re probably 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.
Forward contracts
Unlike a spot contract, a forward contract allows you to fix a favourable exchange rate for future purchases, protecting you against unexpected fluctuations in exchange rates. You’ll usually need to commit to making the transfer within a specified window. 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.
What is the mid-market rate?
The mid-market rate is what your money’s actually worth on the global market compared to another currency. It’s the midpoint between worldwide supply and demand for that currency — and the rate banks and transfer services use when they trade among themselves. Use this rate as a baseline to compare against the rates provided by your bank or transfer service. With it, you’ll discover which companies offer the best rates.
Order options
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 (or have the support of an account handler).
Limit orders
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. The risk with limit orders is that your target might not be reached in the timeframe you had in mind, and your transfer might not execute.
Stop-loss orders
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 – like best-case and worst-case scenarios that you define. If you’re transferring your life savings – perhaps to move abroad, for example – then there’s so much at stake that setting a limit order and stop-loss order gives you a greater degree of certainty.
With both of these order types, it’s a good idea to work with a transfer broker offering expert human support to guide you through the process. A good dedicated account handler can add context around recent trends and levels of fluctuations in currency prices, and any external events that could impact those prices.
Recurring payments
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.
How can I hedge with an online forex broker?
To begin hedging your forex trades, you’ll need to:
- Determine your options. Learn whether your broker offers such hedging tools as forward contracts, limit orders and stop-loss orders or find one that does.
- Assess your risk tolerance. No trade carries zero risk, so you’ll need to determine how much risk you’re willing to take.
- Choose two currencies to trade. Consider pairing the “majors” — for example, dollars and pounds — against the euro.
- Contact a forex broker. If you’re a new client or will make ongoing exchanges, ask if you’re eligible for any bonuses or perks. Then get to hedging your trades.
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