Forex Risk Management Techniques

The need for forex risk management arises when traders who have open positions are willing to cut the size of their potential losses but alternatively there are also another set of traders who are willing to gain massively from single open position. The main aim of trading is to enjoy higher returns but it comes with higher risk. 

The case is similar for corporate which have expected cash flows inwards or outwards depending on being an exporter or importer. If these cash flows are left un-hedged, the case is equivalent to trading. It is at this point there is need to understand what proper risk management is.

Forex Risk Management Techniques can make the difference between survival and sudden death of a trader in the currency market. Even when best trading systems are in place, but no risk management strategies are there, failure would knock on your door sooner than later.

These strategies can come in the form of cutting down on your lot size, entering the market at particular market sessions, hedging, or something as simple as knowing when to cut losses. Corporate transactions encounter different currencies thus have risk of currency fluctuation associated with them. 

One established way of mitigating this currency risk is by taking forward currency contracts. These contracts are not traded on exchanges and are done over the counter (OTC). It is a unique, customized contract agreed upon by two entities to buy or sell a certain amount of a currency at a set rate of exchange at a future date.

Another way to mitigate currency risk is to enter futures currency contract. Here the standardized contracts are traded over the exchange. These are used for speculation and currency hedging. Once a future contract is entered into there is a formal obligation for all entities involved to buy or sell at the terms speculated in the contract.

Option contract is an alternate strategy which is basically a contract wherein entities have agreed to exchange a set amount of currency at a given rate sometime in the future, the entity on one side of the agreement is not obliged to do so, i.e. it has the option to see the contract through or effectively cancel it. This gives that party the option to see through the contract and take the currency at the stipulated rate, or enter the spot market for that currency if its exchange rate is more favorable to that outlined in the option agreement.

Treasury and finance managers can mitigate the forex risk with the help of the above strategies thus providing solutions that allow firms to change their risk profiles and operate with greater certainty. 

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