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Low Volatility Forex Trading
The primary reason for the Forex markets is international trade. A Japanese company that needs to buy American made jets or German machine parts will need to convert Yen to either US dollars or Euros in order to make the purchase. If the exchange rate of the USD to YEN or EUR to YEN changes the company may lose money. So, companies often buy Forex options to contain currency risk. In times of low volatility Forex trading it can be tempting to forego options as the market seems to be stable. Speculators, however, are not usually happy with low volatility Forex trading as the most profitable Forex pair is typically the most volatile Forex pair.
Does the Present Predict the Future in Forex Markets?
Forex markets have been very stable of late. As we noted in the beginning there may be a temptation in international business to avoid the cost of options contracts. This is working under the assumption that the market will stay flat until the company in question needs to exchange their YEN for USD, USD for EUR or EUR for GBP. The fundamentals are what eventually set Forex prices. Careful fundamental analysis of the Forex pair in question will help traders decide if the current flat Forex market will continue. At such time as low volatility Forex trading converts to high volatility technical analysis of Forex currencies will be important. Experienced traders know that low volatility Forex trading will last while it lasts and eventually volatile markets return. As such a conservative approach to converting currencies for business purposes is to use options to hedge currency risk.
Hedging Currency Risk in Flat Markets
The advantage of buying call options in a low volatility Forex market is that options are typically cheap when there is little risk of a price change. The scenario goes like this. The Japanese company that wants to buy an American commercial jet such as the new Boeing Dreamliner will sign a contract for the jet and will expect to pay in the range of $200 million on delivery. If the YEN falls in value in relation to the USD this would make the price of the jet in YEN more expensive. So, the Japanese company buys calls on USD with YEN. If the YEN does fall in value the company exercises the contract and buys the required amount of USD at the fixed exchange rate set by the options contract. If the YEN rises in value versus the dollar the company lets the call options contracts expire and gets to buy the jet for a lower than expected price in YEN. The major factors in times of low volatility Forex trading are that non-volatile markets do not last forever and during times of low volatility Forex trading options contracts are typically cheaper.