cash flow

Multi-Currency Hedge

for Forex

A multi-currency hedge takes opposite positions on two positively correlated currency pairs. For example, consider a short position on EUR/USD. To hedge your USD exposure, open a long position on GBP/USD, assuming they have a high correlation. This strategy results in protection from the Euro falling against the US Dollar.

Unlike the direct hedge (short-long) that results in zero net profit, a multi-currency strategy makes it possible that one position might earn more than the other losses.


Suitability:

all investors

All Investors

Since this strategy only involves forex transactions, it is suitable for all investors.

Protection:

good

Good

A hedge based on multi-currency can provide better protection than a direct hedge.

Cost:

low to moderate

Low to Moderate

In terms of cost, this strategy is the same as any other forex transaction.


Example:

Using the fictitious correlation table below, find the currency pairs most closely related to EUR/USD.

EUR/USD AUD/USD GBP/USD NZD/USD
1 month 0.74 0.95 0.84
3 month 0.77 0.90 0.69
6 month 0.50 0.66 0.66
1 year 0.93 0.89 0.96

If you answered EUR/USD with GBP/USD, you are correct. The positive correlation of 0.95 is excellent. This result means that GBP/USD will mirror a move in EUR/USD 95% of the time. One caveat is during the six-month mark, where the correlation dropped to 0.66. However, over one year, the two currency pairs exhibit an obvious correlation.

Since EUR/USD with GBP/USD is highly correlated, an investor taking a long position in GBP/USD can protect against the British Pound dropping by taking a short position in EUR/USD. However, a new risk occurs with the Euro and the Pound.


Resources:



© 2020 Todd Moses

The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.