Forex Trading is the most lucrative trading in today’s trade world and it seems quite apparent that everyone is ready to jump onto the bandwagon of forex trading. However, it is not as simple as it seems to be. To understand how the forex trade market works, you need proper education about Forex trading and currency trading. Any profit making avenue is accompanied by the commiserate risk with it. In forex trade, the risk can be alleviated by using hedging techniques of forward markets, futures, options and money markets. It is also possible to hedge any currency against any other currency by creating foreign currency hedging contracts based on US dollar denominated future contracts. This is known as Synthetic Foreign Currency Contracts. Assuming that there are market expectations that Australian dollar may depreciate in comparison to the Swiss Franc, a Forex Trader can sell Australian Dollar Futures while simultaneously buying Swiss Franc Futures, the assuring a future exchange rate between the two said currencies. The real benefits in this Forex Trade can be seen in the following situations: * Both the Australian Dollar and The Swiss Franc depreciate in relation to the US Dollar, but the Australian Dollar depreciates more. * Both the Australian Dollar and the Swiss Franc appreciate in relation to the US Dollar, but the Swiss Franc appreciates more. * The Swiss Franc appreciates and the US dollar depreciates both in relation to the US Dollar. In this Forex Trade the money manager will lose on one of the transactions and gain in the other, but he can expect a net gain in the deal. Speculation Using Currency and Forex Trading Speculators differ from hedgers in that their basic objective is to capitalize on the difference between their own forecasts and market expectations. When a speculator is betting on the price movement associated with a particular contract, it is called open position. When the speculator is trying to take advantage of movements in the price differential between two separate future contracts, it is called spread trading. This type of Forex Trading can involve: o The same currency but contracts of different maturities. o Two contracts of same maturity. o A combination of the above. Say, the spot and futures prices are quoted as On Feb14, 2007 Rs/$ Spot = 45.10 March Futures =45.30 June Futures =45.34 September Futures =45.60 If a Forex Dealer is if the view that the market is wrong and the Dollar will actually depreciate. Another speculator agrees with the market that the Dollar will appreciate but thinks that the market is over estimating the extent of appreciation. On September 10, 2007 Rs/$ Spot = 45.5 September Futures= 45.7 (Standard size of a Futures contract is $1000000. The strategy would be to sell Futures now and reverse later as they expect to Dollar to depreciate. Sale Price = 45.6 and Buy Back Price= 45.7 Total Loss per contract = Rs1000000*(45.6-45.7) = Rs100000 There will be a loss of Rs100000 per contract. This loss is due to the Dollar not moving as per their expectations. The Dollar has actually appreciated against the Rupee. Similarly, if on September 10, 2007 the following rates materialize The speculator can buy Back Futures at a price of 45.40 Spot =45.30 September Futures = 45.40 Profit per contract =Rs1000000*(45.60-45.40) =Rs200000
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