News & Analysis at your fingertips.

We use a range of cookies to give you the best possible browsing experience. By continuing to use this website, you agree to our use of cookies.
You can learn more about our cookie policy here, or by following the link at the bottom of any page on our site. See our updated Privacy Policy here.

0

Notifications

Notifications below are based on filters which can be adjusted via Economic and Webinar Calendar pages.

Live Webinar

Live Webinar Events

0

Economic Calendar

Economic Calendar Events

0
Free Trading Guides
Subscribe
Please try again
Wall Street
Bearish
Low
High
of clients are net long.
of clients are net short.
Long Short

Note: Low and High figures are for the trading day.

Data provided by
More View more
Real Time News
  • The Japanese Yen is eyeing the upcoming Bank of Japan rate decision and CPI figures, but JPY crosses will likely remain dependent on broader market sentiment. Get your weekly $JPY forecast from @FxWestwater here: https://t.co/x9rbQpPfWe https://t.co/2x1R5XTVea
  • Consolidation or bull flag? A bull flag is a continuation pattern that occurs as a brief pause in the trend following a strong price move higher. Learn how to better spot these formations here: https://t.co/yOEvLjKnct https://t.co/uCaWQiu4Ly
  • Crude and Brent oil are on track to extend higher as Gulf Coast supply disruptions and a positive OPEC report bolster sentiment. Uranium is on a massive surge, aided by the famous Wall Street Bets group. Get your market update from @FxWestwater here:https://t.co/XrpV0jcy8e https://t.co/g2To3LmUah
  • RT @michaeljburry: Read thread.
  • The Australian Dollar has retraced from August lows when looking at AUD/JPY and AUD/CAD. However, the AUD/NZD downtrend is intact, will a reversal there appear as well? Find out: https://t.co/8LmgqLLGJO https://t.co/AueigVsuk4
  • The S&P 500, Dow Jones and DAX 30 could be at risk of falling as retail traders continue increasing their upside exposure in these indices. What are the key technical levels to watch for? Find out from @ddubrovskyFX here:https://t.co/OJByiwIppr https://t.co/P1iOONG90N
  • The US Dollar continues to hold its ground against most ASEAN currencies as recent downtrends lose momentum. What is the road ahead for USD/SGD, USD/THB, USD/PHP and USD/IDR? Find out from @ddubrovskyFX here:https://t.co/UcleaZEAaW https://t.co/62bGLvt8fE
  • The Canadian Dollar has been caught in broad ranges against the Euro and the US Dollar, but can the upside bias in USD/CAD and EUR/CAD prolong? Find out here:https://t.co/8DubboXsjv https://t.co/A0sIYo2iP1
  • Want to hear my thoughts on the US Dollar? Check out yesterday's recording with #AuzBiz hosted by @KaraOrdway on 'The Trade' We discussed a #USD index, Treasury yields, $USDJPY, $AUDUSD and $NZDUSD https://t.co/yxwquL1btp https://t.co/RtWjlN6kpv
  • Gold has plunged nearly 5% off the Monthly high with the sell-off now probing key weekly support here at 1738/47- looking for a pivot here with the Fed interest rate decision on tap. Get your $XAUUSD market update from @MBForex here:https://t.co/Vnxi41lETt https://t.co/FyZuHNzsU3
Forex Strategy:  The US Dollar Hedge

Forex Strategy: The US Dollar Hedge

James Stanley, Senior Strategist

Talking Points:

  • Trading is much more than just picking a position and ‘hoping’ that the trade works out.
  • Trading is about risk management, and looking to focus on the factors that we know.
  • This strategy focuses on capitalizing on US Dollar volatility, and using risk management to offer potentially advantageous setups in the market.

If there is one pervasive lesson that gets taught time and time again to traders, it’s that future price movements are unpredictable.

While this may sound foreign to ears hearing it for the first time, logic and common sense dictate as such. Human beings can’t tell the future; and our job as a trader is to try to forecast future price movements. This is where analysis comes in, hopefully offering traders an advantage. And further, this is where risk management plays an even more important role, just as we saw in our Traits of Successful Traders research in which The Number One Mistake Forex Traders Make was found to be sloppy risk management.

Forex Strategy:  The US Dollar Hedge

In this article, we are going to look at a strategy to do exactly that.

What is the USD Hedge?

The USD hedge is a strategy that can be utilized in situations in which we know the US Dollar will probably see some volatility. A good example of such an environment is Non-Farm Payrolls. With The United States reporting the number of new non-farm jobs added, quick and violent moves can transpire in the US Dollar, and as traders this is something we might be able to take advantage of.

Another of these conditions is the US Advance Retail Sales Report. This is a vitally important data print that gives considerable insight into the strongest engine of the US economy; the consumer, which accounts for roughly 65% of US economic production. This number is issued on the 13th of the month (approximately 17.5 hours from the time this article is published for the August 2013 print), and fast moves may transpire shortly thereafter.

High impact USD events can be a great way to look for USD volatility

Forex Strategy:  The US Dollar Hedge

The Economic Calendar filtered for ‘High Importance’ USD Announcements

Another example is Federal Reserve meetings; with a very important meeting set to come out next week as much of the world waits to hear whether or not Fed is going to begin tapering the massive easing outlays that they’ve embarked on since the financial collapse to try to keep the global economy afloat.

In all of these situations – it is absolutely impossible to predict what is going to happen.

But once again, as a trader – it is not our job to predict. It’s our job to take the one strain of information that we know will probably happen and to build an approach around that.

In the USD hedge, we look to find opposing currency pairs to take off-setting stances in the US Dollar. So, we find one pair to buy the US Dollar; and a different pair to sell the US Dollar. This way, we offset a portion of the risk of both trades by ‘trading around the dollar.’

A note on hedging

Hedging has a dirty connotation in the Forex market. In the Forex market, hedging is often thought of as going long and short on the same pair at the same time.

This is disastrous, and an atrocity to the term ‘hedging.’ If you buy and sell the same pair at the same time, the only way you can truly profit is from the spread compressing (getting smaller), which means that your top-end profit potential is limited.

In actuality, it’s much more likely that spreads may spike during news announcements which could entail a loss on BOTH sides in this scenario.

Some traders say ‘well, I’ll close out the long at a top and wait for a bottom and then close out the short.’

This just doesn’t make sense. Because if you could time your long exit that well, then why wouldn’t you just initiate the short position there after closing the long position?

You still have to time the market in one of these ‘hedges.’ But extra risk is exposed from the fact that spreads can widen, and potentially trigger stops, margin calls, or any other number of bad events that simply aren’t worth it because there is so little upside of doing so.

The textbook definition of hedging, and this is what is taught in business schools around the world, is that a hedge is an investment that’s intended to offset potential losses or gains that may be incurred by a companion investment.

In the USD hedge strategy, that’s exactly what we’re looking to do.

What Allows the USD Hedge to Work?

Quite simply, risk management; if we’re fairly certain that we’re going to see some US Dollar movement, we can use that in our approach to hypothesize that this movement may continue.

By looking for a 1-to-2 risk-to-reward ratio or greater ($1 risked for every $2 sought), the trader can use this information to their advantage. Advantageous risk-reward ratios are an absolute necessity in the strategy and without them – the USD hedge will not work properly. We looked at this topic in depth in the article How to Identify Positive Risk-Reward Ratios with Price Action.

The trader looks to buy the dollar in a pair, using a 1-to-2 risk reward ratio; and then the trader looks to sell the dollar in a pair, also using a 1-to-2 risk to reward ratio. The risk and reward amounts from each setup need to be roughly equal.

Risk-Reward is what allows the strategy to work properly

Forex Strategy:  The US Dollar Hedge

Created with Trading Station & Marketscope

Then, when the US dollar begins its movement, the objective is for one trade to hit its stop, and the other to move to its profit target.

But because the trader is making two times the amount on the winner than they lose on the other position, they can net a profit simply by looking to utilize win-one, lose-one logic.

How to Make the Strategy Most Effective

There are numerous ways to buy or sell US dollars, and theoretically traders could look to utilize the strategy on any of them.

But to give ourselves the best chances of success, we can integrate some of the aforementioned analysis to try to make the strategy as optimal as possible.

If I’m looking to buy the US Dollar, I want to do it against the currency that’s shown me the most weakness against the dollar of recent. And further to that point – if I’m going to sell the US Dollar I want to do it in the pairing that has shown me the most strength against the greenback.

There are quite a few ways to decide how to do this. Personally, I prefer price action. We looked at quite a few ways of doing this in The Forex Traders Guide to Price Action. Another popular, common way of doing so is by using ‘strong-weak analysis.’ Since we have the constant of the US Dollar in all observed pairs, we can simply grade currency strength by comparing relative performance to the US Dollar. In the recent article Strong & Weak, Jeremy Wagner looked at exactly that process.

-- Written by James Stanley

James is available on Twitter @JStanleyFX

To join James Stanley’s distribution list, please click here.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

DISCLOSURES