This article looks at the different forex strategies categories.
When entering the foreign exchange market, new traders will notice that there are various forex trading strategies available for use. However, these numerous strategies all fall into two broad categories – speculating and hedging. It is important to be aware of the difference as this can affect your trading. Both hedging and speculating will be discussed below.
The hedging category
When a company chooses to sell goods or services in a foreign country, they are generally paid in the currency of that particular currency. However, the currency exchange is in constant flux, causing sales to be valued at a price which may be less than what is desired by the company. In order to avoid a potential loss from fluctuating currencies, the company can hedge the trading pairs. This hedging is a means of protecting oneself against the possibility of damaging currency price movements, helping the company focus on generating profits.
It has been seen that traders in international financial markets will hedge foreign currency exposure in order to gain as much from their investments as possible. For example, a mutual fund manager holding Japanese stocks may hedge against movements in the Japanese yen. This will protect the management against exposure to any fluctuations in price movements in the currency.
The speculating category
The majority of trading activities fall into the category of speculation. This involves the buying or selling of an asset, usually in the face of raised risk, in order to take advantage of a market movement. All trading on the foreign exchange market is done in currency pairs, and the speculating trader is one who believes that the value of one currency will move higher or lower in relation to the second currency in the pair. This means that they believe one currency will increase, while the other fails in the near future.
The majority of foreign currency trading is conducted among liquid and active pairs, and to speculate one must have an understanding of both the market and these pairs. It is recommended that new traders utilise the major currency pairs as there is more information available on these currencies. Furthermore, they are also traded more often than the obscure pairs allowing for greater speculative opportunities.
Additional forex strategies
The above two forex strategies emphasise the relationship of one currency to another; however, there are those that focus on the trade itself. Arbitrage trades involve a trade both buying and selling the same currency at slightly different prices with the hope of making a profit. However, arbitrage trading is rather rare among foreign exchange traders, and is not seen as effective or beneficial. This strategy requires close monitoring and immediate action if trading opportunities present themselves, thus it is not recommended for the new trader.
Another popular trading strategy is the carry trade. This strategy is generally seen among larger players and is often used during times of low market volatility. It involves the selling of a currency with low interest rates and investing the proceeds into a country with high interest rates. This allows the trader to make a profit as long as the relationship between the currencies is stable.