Currency hedging strategy: how to protect your profits from market movements

With a daily trading volume of around $6.6 trillion, the forex market is the largest financial market on the planet.

This global reach exposes it to a multitude of political and economic variables – from monetary policy and economic data to political stability and speculation – the outcome of which dictates the value of one currency against another. This brings currency risk into sharp focus for cross-border business: the potential for adverse exchange rate fluctuations to drive up the cost of international payments, swallowing profits in the process.

Broadly speaking, you can adopt one of two approaches when managing your business’s exposure to this inherent risk – depending on your understanding of how the forex market works:

  • Reactive: a lack of knowledge about currency risk might leave you considering a reactive approach to exchange rates. This short-sighted tactic involves crossing your fingers and hoping they move in your favour when the time comes to execute payments. Yes, this might pay off occasionally, but if the rate suddenly heads in the wrong direction, you will be left cursing your luck and counting the cost.
  • Proactive: Rather than leaving your business’s finances in the hands of lady luck, adopt a proactive approach to managing currency risk. This pragmatic mindset is applied by businesses that understand the importance of monitoring the market and planning for any eventuality, allowing them to rest assured that adverse rate fluctuations won’t impact their bottom line.

Protecting Your Profits from Market Movements - Currency Map

Aware that a proactive approach is the most prudent approach to currency risk management, it’s time to put a strategy in place. There’s no “one size fits all” plan for protecting your profit margins from this threat. Therefore, a bespoke hedging strategy that considers your business requirements, commercial context, and risk appetite risk will leave your business well-positioned to execute effective solutions that match its goals.

What is hedging?

Market movements are out of your hands, so you must do everything in your power to mitigate the uncertainty associated with exchange rates – and regain control over your international payments. Hedging is a methodology that allows you to remove – in part or in full – the impact of rate fluctuations on the cost of sending money overseas.

Timing is key when it comes to currency. Hedging controls this by enabling your business to lock in future exchange rates. This ability to mitigate the impact of currency market risk is achieved by engaging in financial contracts that protect against volatile rates. The extent to which your business hedges its position depends on the level of risk it’s exposed to and seeking protection from.

Establishing a hedging strategy

To establish a robust hedging strategy that enhances your business’s international payments, you must plan, develop, execute, and monitor this vital process. Adopting a holistic view of currency risk management will help you establish a comprehensive strategy that safeguards your international payments against currency market volatility now and in the future. This should include:

  • Understanding your risk exposure – analyse your business’s exposure to currency market risk so you can understand your risk appetite.
  • Developing your hedging strategy – armed with this knowledge, you can plan solutions that reduce risk through the application of relevant currency tools – from simple spot contracts and forward contracts to technical currency option contracts.
  • Executing your hedging strategy – you must understand the fluid currency market conditions that impact the timing of your transfers using the solutions you have chosen to execute – so you can make informed trading decisions.
  • Reviewing your hedging strategy – your strategy must be flexible enough to evolve with the dynamic nature of business and economic conditions. To achieve this, you should regularly report on the performance of your strategy, so you can understand your exposure to the market and adjust accordingly.

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Get help from the experts

Don’t fall into the trap of accepting currency risk as the norm, leaving your finances exposed to unforgiving market movements. Achieve the foresight your business needs to gain a firm footing within currency markets by working in partnership with a specialist in corporate foreign exchange, like Central FX. We use our extensive knowledge and experience of managing currency markets to help your business implement a pragmatic approach to risk management using tailored solutions.

We will take the time to develop an in-depth understanding of your business’s unique requirements, commercial context, and market expectations. Armed with this vital knowledge, we can help you define the risks your business faces, identify their potential impact, and tailor a bespoke hedging strategy that’s aligned to your unique risk appetite – so you can adopt that all-important proactive approach to currency risk management.

To speak to us about how we can protect your business from any significant currency moves,

get in touch with Central FX.