Don't fear currency volatility – Keep Calm and Control the Risk!

 

The Bank of International Settlements estimates that the global foreign exchange market processes $4 trillion (twelve zeroes) in contracts on an average day. More than 95% of that volume is transacted for speculative purposes so the niche of the market that involves physically paying for goods and services or moving funds for asset purchase and sale is a mere $200 billion a day. Seems hardly worth it doesn't it.

However, because the exchange rates themselves are driven by the total volume of trade and by trader sentiment, even those of us in the minority physical delivery market are directly affected by the volatility that the speculators create.

But should that make you shudder with nerves or smile because of the opportunity it creates?

For most businesses and financial professionals, the former is the answer. 'Avoid volatility', 'protect against volatility' are the mantras and so they should be but those who see a 5% move in the Sterling – Australian Dollar exchange rate or 3% in the US Dollar to Japanese Yen rate as opportunities, can still take advantage whilst protecting against the inherent risks.

The key to taking advantage of that volatility is to be, above all else, risk-averse. There is absolutely no point in gambling your hard earned profit margin on a hoped-for exchange rate movement. For many businesses, even in these slightly less depressed market conditions, the difference between a P&L figure with or without brackets around it is just a few percentage points so the possibility of throwing that positive figure away with a minor exchange rate movement is very real indeed.

It may sound like the pitch of a late night shopping channel presenter but it really is possible to protect your bottom line whilst having the opportunity to enhance it as well. The challenge was never to have your cake and eat it but to eat your cake and still have it.

Protecting your profit margin even where currency exchange is necessary, is very simply done with automated Stop Loss orders. These guarantee a minimum exchange rate but don't trigger unless that rate is breached. These orders are available from some specialist brokers like Halo Financial and they are widely used by companies to ensure their cost price is maintained whilst they remain able to take advantage of any positive exchange rate movement. To use these and place them effectively, you do need to either be a Technical Analyst yourself or to recruit the services of one through either an outsourced resource or via a qualified broker.

The chart above is an example of how technical analysts might see the Euro – US Dollar exchange rate over the last 2 years. The upward trend is fairly obvious and a protective stop loss order could have been deployed to guarantee an improving minimum exchange rate as the market moved higher. For someone with a long term project or contract, their overall gain could have been as much as 11.5% over this timescale and the cost would have been precisely $0.00.

It should be mentioned that there are other opportunities to implement the same sort of protection through derivative products called Options. These confer the right but not the obligation to purchase a specified amount of currency at a predetermined exchange rate. They differ in that, even if the exchange rate fell below the minimum level, you are not obliged to transact at that rate through your option. In contrast, a Stop Loss order will trigger automatically as soon as it is hit. The downside to Options is that they carry a premium cost which is non-refundable or, if no premium is required, they will carry a penalty clause of some description. It is essential that you take advice before entering into any option package because of these penalty clauses.

In essence, volatility is easily tamed, not at all risky if you manage the risk well and it very definitely can offer all manner of opportunity once the risk has been contained.

By David Johnson, Technical Analyst and Director, Halo Financial.

For a free no-obligation consultation, call +44 207 350 5470. Or visit www.halofinancial.com/mei  

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