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For stock traders venturing into international markets, currency fluctuations can significantly impact their portfolio’s performance. A strong local currency against a weakening foreign currency can erode the value of your foreign stock holdings, even if the underlying company performs well. This is where currency hedging comes in. Hedging with spot forex allows stock traders to mitigate this risk and protect their overall returns.
Understanding Currency Risk
Imagine you buy shares of a promising Japanese tech company listed on the Tokyo Stock Exchange. Even if the company’s stock price increases in Japanese yen (JPY), a strengthening Singapore dollar (SGD) against JPY can translate to a net loss when you convert your JPY profits back to SGD. This highlights the importance of managing currency risk, especially for long-term investments in foreign stocks.
Spot Forex as a Hedging Tool
Spot forex, also known as foreign exchange, refers to the simultaneous buying and selling of currency pairs at the current market rate. Stock traders can leverage spot forex to hedge their currency exposure by taking an opposing position in the relevant currency pair.
Hedging Strategy with Spot Forex
- Direct Hedge
Here’s how a direct hedge works:
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Benefits of Hedging with Spot Forex
- Reduced Currency Risk: Hedging minimises the impact of unfavorable currency movements on your portfolio’s overall performance.
- Peace of Mind: Knowing your portfolio is protected from currency fluctuations allows you to focus on analyzing the underlying companies’ performance.
- Potential for Additional Profits: If the foreign currency strengthens against your local currency, your short position in the spot forex market will incur a loss. However, this loss might be offset by the gains from your appreciating foreign stock holding.
Considerations when Hedging with Spot Forex
- Transaction Costs: Buying and selling spot forex contracts involve bid-ask spreads, and overnight holding fees. These costs could eat into your potential profits, so it’s crucial to factor them into your calculations.
- Hedging Duration: The duration of your hedge should be aligned with your investment horizon. Short-term hedges can be used for swing trading, while long-term hedges are suitable for buy-and-hold strategies.
Conclusion:
Hedging with spot forex offers stock traders a powerful tool to mitigate currency risk and protect their portfolio’s value. By understanding the hedging strategy available, their benefits, and the associated considerations, you can make informed decisions about incorporating spot forex into your international stock trading strategy. Beyond mitigating your currency exposures, there are also other forms of hedging, you may read our full article on using Shares CFD to hedge against portfolio risk here.
What’s Next?
Check out our Spot FX offerings on Phillip Nova 2.0. Simply navigate to your watchlist, click on the ‘+’ icon located at the bottom of the page, and select ‘FX’ to view and add your desired currency pair to start trading. Check out our step-by-step guide here to add CFDs to your watchlist!
