Using derivatives to navigate risk and trade in FX markets

Using derivatives to navigate risk and trade in FX markets

Instruments such as IG’s Knock-Outs and Direct Market Access can help enhance the trading experience.

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FX derivatives give traders the ability to trade in currencies without the underlying asset ever being physically transferred. Photos: Shutterstock

With the current uncertainties present in markets, there has been a growing interest in employing derivatives to navigate risk and capitalise on opportunities when trading in currencies. Rather than investing in physical currencies in the spot forex (FX) market, investors can consider derivatives, which can help them to better manage FX risk while profiting on potential trading opportunities.

In the FX market, trades are executed and completed as soon as possible after confirmation, similar to buying any other type of asset classes. Spot FX trades require the physical delivery of the underlying asset. However, FX derivatives give traders the ability to trade in currencies without the underlying asset ever being physically transferred.

One such derivative product is Contracts for Difference (CFD), which enables traders to speculate on price movements, both upwards and downwards.

In a typical FX CFD trade, a client and a broker go into a contract where both parties will agree to the exchange of price difference in the current value of an underlying currency and its value at the end of the contract.

This means that traders have the opportunity to make a profit regardless of whether the currency’s price rises or falls. For example, if you are keen in trading USD/JPY and you foresee that the currency pair will weaken, you can take a short position on the currency. If you expect the currency pair to strengthen, you can take a long position.

As you are able to take short positions, CFDs can also act as a hedge for your portfolio. For instance, if you own a US stock that is quoted in USD, and you expect the US currency to fall in value, you can open a short position in CFD on USD to offset potential forex losses.

To add another level of safety, IG’s latest CFD product, Knock-Outs, helps mitigate the risk in FX trades by allowing you to determine the exact price you would like your trade to close by setting your Knock-Out level at the start.

The Knock-Out price moves one-to-one with the underlying price of the asset and you only pay for the stop if the Knock-Out level is triggered. The Knock-Out level acts like a guarantee that closes out your trade even during times of huge market swings or market slippages. This is particularly useful for the volatile landscape, and for investments such as FX, which trade around the clock.

If you trade FX CFDs in large volumes, you can take advantage of IG’s volume rebate scheme. Under this scheme, you can receive a rebate of up to US$10 (S$13.50) per million traded, depending on the FX notional volume you trade per month.

FOREX DIRECT: MINUS THE MIDDLEMAN

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More advanced traders can utilise what is known as Direct Market Access (DMA), which is a type of FX execution that offers traders access to the physical market without intermediaries.  

Traditionally, FX trading is conducted through a broker, who will request quotes from exchanges and market makers, and then present the best price to their client. DMA, however, is an electronic trading mechanism that enables you to see the different orders and prices yourself, and place your trade accordingly.

With an FX DMA service such as IG’s Forex Direct, you can trade in FX markets without the need for a middleman. The platform gives you the best bids and offer prices, higher liquidity, faster execution and more control over your trades. DMA also offers market transparency, extended data on currency pairs and prices from a wide selection of global banks and liquidity providers.

Here is how an FX DMA works:

  • DMA displays the best bid and offer price available for a particular market, plus further prices on either side of the order book.
  • After placing an order, IG instantly conducts a margin check to ensure you have sufficient funds to cover the margin on your proposed trade.
  • If the margin check is successful, IG places an order in the market and, at the same time, creates a parallel CFD between you and them.

While FX CFDs are traded in contracts and are commission-free, FX DMA is traded in lots and comes with a variable commission. Both instruments are available to all IG clients on both web and mobile apps.

Amid a volatile investment landscape, traders looking to capitalise on emerging market opportunities can leverage innovative products such as FX CFDs and FX DMAs.

Visit IG to open an account to trade CFDs. Download IG’s free Bloomberg e-book on FX: Trading on a high note.

Disclaimer: IG provides an execution-only service. The information in this article is for informational and educational purposes only and does not constitute (and should not be construed as containing) any form of financial or investment advice or an investment recommendation or an offer of or solicitation to invest or transact in any financial instrument. Nor does the information take into account the investment objective, financial situation or particular need of any person. Where in doubt, you should seek advice from an independent financial adviser regarding the suitability of your investment, under a separate arrangement, as you deem fit.

No responsibility is accepted by IG for any loss or damage arising in any way (including due to negligence) from anyone acting or refraining from acting as a result of the information. All forms of investment carry risks. Trading in leveraged products such as CFDs carries risks and may not be suitable for everyone. Losses can exceed deposits.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

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