A pertinent question for many businesses is: how can we effectively manage our currency needs? David Johnson, director at foreign exchange brokerage Halo Financial, shares the factors to consider.
Every company is different; the personnel, your experience, the markets you operate in, and the unique position you occupy within those markets will all affect how you manage your foreign exchange needs. Understandably, with such diversity, there isn’t a universal template for good currency management, but there are some common factors. Manage these well and you will improve your risk management as well as the exchange rates you achieve.
Those factors are broadly broken down into:
- Your currency source
- Risk management
Most companies evolving into international trade naturally gravitate to their bank when it comes to the foreign exchange aspects of that trade. However, as time passes, many choose to move to a specialist, external source such as a broker. There are advantages of using a bank; all funds are in one location and transfers across accounts or out from accounts can be made very simply. However, the facilities offered by banks can be very variable and the crucial elements of timing and flexibility are often lacking.
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A good broker is one who will help with relevant and timely information, will provide a wider range of contract types (tools for the job) and offers swift and effective settlement.
When does your foreign exchange exposure start? Perhaps the exposure begins with your first order, first sale or first invoice, or maybe it is much earlier in the planning phase of the business or project. Whenever the amount and the currency can be determined, your funds are immediately exposed to the uncertainties of the foreign exchange market. Planning is the key to good forex management.
Your profit or loss will be determined by where you set your ‘cost’ level on the exchange rate. Sales directors don’t take kindly to seeing their hard earned gross profit wiped out by a currency fluctuation and the marketing department will wail if they have to reprint sales brochures due to exchange rate movement.
These sorts of hassles can almost always be avoided through the use of technical analysis of the currency pair in question. A well-positioned cost price will allow for some flexibility, but will be able to be protected by the right risk management measure. The days of ‘we win on some and lose on others’ need never return.
If you are an out and out gambler, you may decide to leave everything until the last moment. The risks of negative exchange rate movements are enormous and the effect that could have on your profitability are obvious. However, it is surprising how many businesses take this route.
The Right Tools
How you manage risk will be determined by your attitude to risk, the nature of your business and the market you are involved in, and by just how determined you are to cut out currency losses.
If you are risk-phobic, you can buy all your currency requirements as soon as you know the exposure exists. That can be done either for spot (immediate) settlement or for forward settlement; setting a settlement date for the contract some time into the future but agreeing an exchange rate today. Spot trades require that you have the cash-flow to be able to settle straight away whereas forward contracts can usually be secured with a minimal deposit and the balance settled at the delivery date.
If you are able to have a more flexible attitude to risk and the market conditions allow for it, you may wish to secure your cost level through an automated Stop Loss Order (SLO) or perhaps an Option which would leave the opportunity to take advantage of any beneficial exchange rate movements.
Stop Loss Orders and options act as a safety net below the current exchange rate, guaranteeing a worst case exchange rate. They differ in a few key areas. There is no charge for placing an SLO and if the market drops to your chosen exchange rate, the order will be triggered and you will have secured your currency even if the exchange rate bounces back.
With an option, you will either pay a premium or be locked into some less attractive clauses if you don’t pay a premium. However, you have the right to buy at your selected level but you are not obliged to do so. A note of caution: before entering into an Option, double check the caveats and conditions because some of the penalties can be onerous.
There is another automated order, which can be called a ‘Take Profit Order’ or a ‘Limit Order’. This is placed at a level above the current exchange rate and is used to target an advantageous price. As with the SLO, if the market rate reaches the required level, your order will be triggered and you will buy at the selected rate.
Automated orders are particularly attractive for the 24 hour nature of the cover they provide. Wherever in the world the order is triggered, you will achieve your desired outcome. Some of the most volatile times in foreign exchange trading occur when London is closed (London handles 40 per cent of the market liquidity) and during the transitions between markets.
As with good comedy, good currency transactions happen through good timing. $5.3 trillion travels through foreign exchange markets each day according to the Bank of International Settlements. So no one and no corporation can control the market. You can however, work with known trading ranges and a chartist (technical analyst) will be your greatest ally in determining expected highs and lows.
Using those forecasts to set target exchange rates or to trade at the tops or bottoms of ranges means you can not only aim for the tops of ranges, but can take advantage no matter when and where that order might be triggered.
Ultimately, your success in managing currency risk will be determined by the facilities available to you, your strategy and the market movement itself. Some things you cannot change but it is a simple task to review and amend your procedures to ensure you aren’t susceptible to forex market volatility. Because, one thing that is certain: there will always be volatility in the world’s largest market.
For more information on Halo Financial, visit www.halofinancial.com.