Honestly doe, I think I am in love
In currency trading, I used to hedge risk by trading multiple currency pairs – but I would only trade the majors.
The majors usually include USD.
And so I would usually end up with a massive net long or short USD position – and any small fluctuation in the dollar would present a big risk to my account.
Yesterday I had an awesome idea.
Why not hedge out the USD risk on these majors positions, by trading cross-pairs in the opposite direction to the other currency in the USD pair?
So, say I’m selling AUDUSD on the basis of monetary policy divergence between the RBA and the Fed.
To hedge it, I would buy AUDJPY.
This effectively eliminates AUD risk in this position.
Furthermore, it hedges out any dollar downside because if the dollar falls, it will be because Fed hike probability falls. Thus equities should rise, prompting a sell-off in JPY and a rally in AUDJPY.
And since we expect the RBA to remain on hold anyway, AUDJPY should appreciate. It gives us some nice carry too.
Another example: say I’m buying USDCAD because I think the Federal Funds Rate will rise in the near future.
To protect ourselves against this short CAD position, we can sell GBPCAD.
This is because Sterling faces the risk of Brexit and further rate cuts – CAD doesn’t face nearly as much risk, and it gives us a nice long CAD trade if oil decides to go up.
To put it mildly,
I’m frigging excited with joy about some stupid currencies.
Such is life