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The fascinating thing about the Forex market is the ability of traders to take part of world events on different scales and basically hedge theirs life.
As an example I visited Europe with a friend in February 2010. We booked the trip early December 2009. I figured the whole trip would cost us USD 20,000 at the exchange rate of 1.5094 as of December 2, 2009. We had to pay February 15, 2010.
Our expenses would fall if the Euro declined against the US Dollar, but would raise if the Euro would increase. We looked at the chart of my Forex trading system and saw that the dollar was trading at 1.5094 when we booked the trip.
Actually I wanted the Euro to decline for our trip so our cost would also decline. Never the less, just because I wanted the Euro to decline didn’t mean that it would. If the Euro took off, our trip could get considerably more expensive. The current situation of the Euro was very unstable. It could raise or fall. But probability for the Euro of coming down was much higher because of the situation of the terribly weak economy and the overdone spending in Greece, which belongs to the Euro.
Since a regular contract represents USD 100,000 in US currency, it was much too big for us to use as a hedge. The minis on the contrary each represent USD 10,000 worth of US currency, so this is where we set up a position.
Looking at our FOREX chart, we place a sell stop order for 2 mini EUR/USD-contracts at 1.5093, one pip below the current price. This sell stop order means that I would get into the market only when it trades down and through 1.5093. I would be getting stopped into a short position.
I decided to do this at the lower price, instead of the immediate price, in case the Euro did roll over and increase. If it increased from when we booked our tickets, it would be a loss for us, as our trip will get more expensive with each increase. However, if the Euro fell, it could start a massive rally and ease our trip budget.
One mini represents USD 10,000, so I was essentially hedging USD 20.000 worth of US currency, with the two minis.
On February 15, 2010, almost 2 months later we closed the trade. The Euro had a big fall to 1.3645, for us a gain of 1449 pips (1.5093 – 1.3644 = 0.1449). Two minis equal a gain of USD 2898. They eased our budget considerably. Instead of paying USD 20,000 as we had figured out, we only paid USD 17,102.
There are many other opportunities people can hedge in the Forex markets. If someone wants to hedge his USD 100,000 savings against a weakening dollar, he can buy one contract of EUR/USD, and have a perfect hedge. Or he can actively take part using Forex trading robot.
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