Distinguishing Forex Traders Based on their Strategies

Hedging currency fluctuations, placing a bet according to the anticipated rise or fall of currencies, as well as earning profit from the price differential are the three popular forex trading objectives that help us distinguish between different types of traders in the forex market. Given below are some of the key points and basic strategies of ways of working of each of this trader type:

Hedgers – These investors are basically risk-averse individuals who are not too keen to bear the excitement that comes with currency rate fluctuations. These traders are more interested in safeguarding what they have instead of aiming for a huge profit. This technique of hedging is also helpful for corporations (especially export related) and investors to have a steady stream of profit as they assume a different position in the derivatives market.

In simple words, you may compare it to being insured against the possibility of a loss that may arise because of constantly changing currency rates. Although you cannot completely nullify the possibility of a loss, you can still control how much you lose by hedging. It is difficult to have perfect hedge but it is a relief for these investors to know that their loses would be minimal even when the market trend doesn’t go in their favor.

For instance, ABC Ltd. with their headquarters in the US, has a subsidiary one in Japan. In case the price of Japanese Yen goes down, it would decrease the profit or revenue in their Japanese segment. To combat the business loss in such a situation, ABC can make a short position in Yen and hedge their current position. So, if the Yen continues to fall even more, their short position will fetch them profit in future and cover up their previous business loss.

Arbitrageurs – These investors are often the ones who are involved in two different exchanges, contracts, or markets, so that they can benefit from price inefficiencies simultaneously. Mostly, price inefficiencies are very much dependent on time. As a result, when the gap is available, one usually needs to act very quickly, or the opportunity will soon be lost. This is typically a very low risk strategy as one can trade only if an opportunity exists for him to act.

For instance, if the exchange rates are:

EUR/USD = 0.6522 (New York)
EUR/USD = 0.6524 (London)

In New York, you can buy 6522 Euros in exchange of $10,000. In London, it will take you $1000 more to short 6524 Euros. Hence, this can help the trader gain 4 pips without taking any risk.

Speculators – The strategy followed by speculators are almost similar to those of debt or equity traders. They assume one position in order to earn profit from price fluctuations. These traders normally look forward to substantial profit on their investments and thereby their investments usually involve a good amount of risk too.

For instance, if US GDP has fallen and speculators short US dollars, anticipating that this would weaken USD, in that case if the anticipated fall in the USD actually happens, speculators earn a profit. These traders render substantial liquidity to the forex market. All investment strategies discussed above have their pros and cons. It is all a matter of choice, as to which forex trading objective you wish to prefer.