What Is Hedging?

The concept of hedging is based upon the assumption that movement in cash and futures prices will parallel each other in movement after due allowance has been made for any seasonal or other trend in the cash market.

In essence, the goal of the hedger is to lock in an approximate future price in order to eliminate his risk of exposure to interim price fluctuations.  The best way to understand hedging and the futures market is by example.  I will assume that you have no understanding of the futures market.

The Components of a Complete System

A  Complete  Trading  System  covers  each  of  the  decisions  required  for  successful

trading:

•      Markets - What to buy or sell
•      Position Sizing - How much to buy or sell
•      Entries - When to buy or sell
•      Stops - When to get out of a losing position
•      Exits - When to get out of a winning position 
•     Tactics - How to buy or sell

Markets – What to buy or sell
The first decision is what to buy and sell, or essentially, what markets to trade. If you trade too few markets you greatly reduce your chances of getting aboard a trend. At the same time, you don’t want to trade Markets that have too low a trading volume, or that don’t trend well.

Position Sizing – How much to buy or sell
The decision about how much to buy or sell is absolutely fundamental, and yet is often glossed over or handled improperly by most traders. How  much  to  buy  or  sell  affects  both  diversification  and  money  management. Diversification is an attempt to spread risk across many instruments, and to increase the  opportunity  for  profit  by  increasing  the  opportunities  for  catching  successful trades.  Proper  diversification  requires  making  similar,  if  not  identical  bets  on  many different  instruments.  Money  management  is  really  about  controlling  risk  by  not betting so much that you run out of money before the good trends come. 
How  much  to  buy  or  sell  is  the  single  most  important  aspect  of  trading.  Most beginning traders risk far too much on each trade, and greatly increase their chances of going bust, even if they have an otherwise valid trading style.

Entries – When to buy or sell
The  decision  of  when  to  buy  or  sell  is  often  called  the  entry  decision.  Automated systems generate entry signals which define the exact price and market conditions to enter the market, whether by buying or selling.

Stops – When to get out of a losing position Traders who do not cut their losses will not be successful in the long term. The most important thing about cutting your losses is to predefine the point where you will get out before you enter a position.

Exits – When to get out of a winning position Many “trading systems” that are sold as complete trading systems do not specifically address the exit of winning positions. Yet the question of when to get out of a winning position is crucial to the profitability of the system. Any trading system that does not address the exit of winning positions is not a Complete Trading System.

Tactics – How to buy or sell Once a signal has been generated, tactical considerations regarding the mechanics of execution become important. This is especially true for larger accounts, where the entry and  exit  of  positions  can  result  in  significant  adverse  price  movement,  or  market impact.

Spot Trading

Currency spot trading is the most popular foreign currency instrument around the world, making up 37 percent of the total activity.

The fast-paced spot market is not for the fainthearted, as it features high volatility and quick profits (and losses). A spot deal consists of a bilateral contract whereby a party delivers a specified amount of a given currency against receipt of a specified amount of another currency from a counterparty, based on an agreed exchange rate, within two business days of the deal date. The exception is the Canadian dollar, in which the spot delivery is executed next business day.

The name "spot" does not mean that the currency exchange occurs the same business day the deal is executed. Currency transactions that require same-day delivery are called cash transactions. The two-day spot delivery for currencies was developed long before technological breakthroughs in information processing.

Dollar Would be the Primary Benefactor of Volatility or a Market-Wide Risk Reversal Next Week

The benchmark dollar has plenty of event risk over the coming week; but compared to some of the highlights on other dockets, its listings are far from critical. Even so, the greenback will remain at the center of any momentous changes in the FX market derived from underlying shifts in speculative expectations thanks to its principle role as the world’s most liquid currency and begrudgingly-accepted safe haven status. Taking stock of the pressure that has built up behind the capital markets in general; we find many pairs and assets closed this past Friday’s trading session on the verge of trend-defining reversals. Acting as the benchmark for the majors, EURUSD closed just above a well-worn pivot see at 1.35. If sentiment is at risk, then the threat of reversal on a nine-month bull trend for the yield-heavy AUDUSD and NZDUSD should come as little surprise. Yet, giving greater credence to the dollar’s own intrinsic strength; the safe-haven balanced USDJPY and USDCHF pairs are both standing at the threshold of another phase of its February rally. What decides whether this is a short-lived live FX-based correction or a true speculative reversal, though, is complicity from the other asset classes. The 10-year Treasury note looks ready to rebound from nine-month lows, the S&P 500 is well-passed overbought and even gold is looking dangerously speculative. What we need is a catalyst and conviction.

If we want a genuine and pervasive transformation in the backdrop for speculative appetites, the tipping point will most likely be a deterioration in confidence in Europe’s financial conditions, concern that China’s inflation fight will panic global speculators or that the Bank of England’s austerity experiment will prove an disastrous example to the rest of the world. Compared to these looming threats, the dollar’s qualities are relatively benign and its positive characteristics require outside encouragement. That said, the docket will offer a thorough update on the economy’s progress towards recovery. Retail sales, housing starts, industrial production and capital flows are all critical to economic performance. The CPI data will play a unique role in shaping expectations for the eventual rate hike, and potentially before that, the withdrawal of the economy’s record stimulus.

And, though there is a dense round of predictable event risk ahead of us to threaten a near-term drive in risk appetite trends; we should also keep perspective of those fundamental developments that are further down the road. Though largely overlooked on Friday, the Treasury released a report offering up the proposal to wind down Freddie Mac and Fannie Mae. Essentially inevitable, there are far deeper connotations to this eventual effort than just exit of a stopgap for future disruptions in the housing market. These two GSEs hold a tremendous amount of toxic mortgage-backed debt that the market seems to have believed simply disappeared after the worst of the financial crisis. When market participants start to speculate on the influence of this transfer of assets back to the public space, the effects could be crippling.