Portfolio Hedging With Forex

All too often, investors get caught up with how much they hope to make in their portfolios and they forget about keeping what they already have. Your first priority, as an investor, should always be to protect your principal. Once you’ve taken care of that, you can start focusing on making that money work for you. The currency market offers tremendous protection for your other investments.

A hedge is a series of bushes or small trees that have been planted in a row to distinguish one plot of land from another. Medieval English landowners and privacy-starved celebrities are famous for their hedges. The landowners planted hedges because they wanted to define boundaries and create limits to protect their land. Celebrities plant hedges to provide a barrier between themselves and the paparazzi. But these two groups of people aren’t the only ones who create hedges. In fact, everybody does it.

Hedging--or protecting--your property or privacy is a natural instinct. We deposit our money in a bank to keep it safe. We keep our valuables in a safe or a safety deposit box to ensure that nothing bad happens to them. We lock our doors and install security systems to protect us from anything that may be dangerous. We put up fences around our yards. We put passwords on our computers. Basically, we protect everything we own.

Everything, that is, except the value of our money. We protect the money itself by placing it in banks, safety deposit boxes and the like, but we rarely protect its value. The value of our money is exposed to at least one of two financial risks: market risk and inflation risk.

Market risk is the risk you accept when you put your money in the market, be it stocks or bonds. If the market crashes, the value of your investments will also crash. True, the broker handling your investments may be a strong company with impeccable standards, but the fiscal and ethical prowess of your broker has very little to do with the safety of your investments. Regardless of the strength of the firm you invest through, you are still exposed to market risk.

Foreign exchange (or Forex) investing is the solution to market risk because you can offset your losses in the stock or bond market with your gains in the Forex market. You can place trades in the Forex market that will profit from the decline in the stock or bond market. By doing this, as your balance in your stock or bond account declines, the balance in your Forex account is increasing. When you look at your overall portfolio using this strategy, you will notice you have not lost any money. You hedged against the losses resulting from market risk by investing in a different market, Forex.

“I’ve taken care of market risk,” you may say. “I’ve put my money in CDs, money market accounts and bonds. No matter what happens, I will never lose my principal.” While this may be true, you have still accounted for only one of the two financial risks. You may never lose your principal, but conservative investments do not protect you from inflation.

Inflation risk is a risk you have to accept. You cannot escape it. Inflation decreases the purchasing power of money. This means that as inflation continues, you will be able to buy less and less for $1, and your savings and investments will lose their value. The price of U.S. postage stamps provides a great illustration of the effects of inflation. In 1960, the price of a stamp was less than 5 cents. Today, the price of a stamp is 39 cents. That is an increase of nearly 700%. Obviously, $1 bought a lot more in 1960 than $1 buys today, and that trend is only going to continue. If inflation rises at a higher percentage than the percentage of return you are receiving from your conservative investments, you are actually losing purchasing power even though you are making money.

The Forex is the solution to inflation risk because you can offset your loss of spending power with your gains in the Forex market. Inflation affects the Forex market in a fairly predictable manner. Knowing this, you can make your Forex trades accordingly and profit from rising inflation. You can then take these profits, combine them with the profits from your other conservative investments, and nullify the effects of inflation.

Remember, you need to protect the money you have before you go out and try to make more money. But once you’ve mastered how to hedge your portfolio, you should definitely look to the currency market to boost your returns. In fact, you can take advantage of a lot of the negative things in your life and turn them into money-making opportunities.