Forex Investment and Currency Trading

Rollovers
A rollover is the process whereby the settlement of an open trade is rolled forward to another value date. The cost of this process is based on the interest rate differential of the two currencies.

In the spot FOREX market, trades must be settled within two business days. For example, if a trader sells a certain number of currency units on Wednesday, he must deliver an equivalent number of units on Friday. Yet currency trading systems may allow for a rollover, with which open positions can be swapped forward to the next settlement date (giving an extension of two additional business days). The interest rate for such a swap is predetermined, and, in fact, these swaps are actually financial instruments that can also be traded on the currency market.

In any spot rollover transaction, the difference between the interest rates of the base and counter currencies is reflected as an overnight loan. If the trader holds a long position in the currency with the higher interest rare, he would gain on the spot rollover. The amount of such a gain would fluctuate from day to day according to the precise interest-rate differential between the base and the counter currency. Such rollover rates are quoted in dollars and are shown in the interest column of the FOREX trading system. Rollovers, however, will not affect traders who never hold a position overnight, since the rollover is exclusively a day-to-day phenomenon.

Some brokers will automatically roll over open trades while others may liquidate orders that exceed the two-day limitation. Also some dealers may append a rollover charge in addition to the interest differential. Rollover credits or debits are reflected in the unrealized profit-and-loss column of the open position.

If you intend to maintain open positions longer than two days, carefully read your dealer’s policy agreement, or consult their customer service department. Also note that rollover costs may affect margin requirements.

Hedging
A hedge is a position or combination of positions in one security that reduces the risk of your primary position in the same security.

An example of hedging in commodity futures is the Midwest farmer who grows #1 Soft Red Wheat and intends to take his harvest physically to market for September delivery. After rilling the soil and planting the seeds in late spring, die farmer initiates a short (sell) commodity futures contract for September Wheat at the Chicago Board of Trade at what he feels is a fair price. If the price of wheat declines dramatically in September, the farmer will suffer losses on his physical delivery but will make profits on his futures contract. If the price of wheat rises substantially in the fall, the farmer will make profits on his physical delivery but will suffer losses on his futures contract. Thus, hedging not only reduces risk but can also be used to lock in predetermined profits in some situations.

Normally when you have an open position to buy or sell at your FOREX dealer, and you open a new position in the opposite direction, the two positions will close each other out. If you had a position for USD/CHF to buy and you opened a new position USD/CHF to sell, both positions would close, since you cannot be buying and selling currencies at the same time. The feature of hedging however, allows you to do exactly that if your FOREX dealer offers this trading feature.

When you open a hedge position, both positions (the original and the newly hedged one) will remain open. You will have two positions, going in the opposite direction of each other in the same currency pair. This is basically used to lock your current loss or win, until you have a better understanding of where the market is moving. Theoretically, profit is to be gained by skillful timing of the liquidation orders. If liquidated at the same time, the trader will automatically lose the transaction cost.

Brokers who offer hedging do not normally require additional margin for the second hedged position. Consult your broker for details before attempting to apply this rather esoteric trading strategy. You can hedge a speculative position, but it remains speculative and is not considered a legitimate hedge.

Arbitrage
In general, arbitrage is the purchase or sale of any financial instrument and simultaneous taking of an equal and opposite position in a related marker in order to rake advantage of small price differentials between markets. Essentially, arbitrage opportunities arise when currency prices go out of sync with each other. There are numerous forms of arbitrage involving multiple markets, future deliveries, options, and other complex derivatives. A less sophisticated example of a two-currency, two-location arbitrage transaction follows:

Bank ABC offers 120 Japanese Yen for one US Dollar and Bank XYZ offers only 100 Yen for one Dollar. Go to Bank ABC and purchase 120 Yen. Next go to Bank XYZ and sell the Yen for 100. In a little more than the time it took to cross the street that separates the two banks, you earned a 13 percent return on your original investment. If the anomaly between the two banks’ exchange rates persists, repeat the transactions. After exchanging currencies at both banks six times, you will have more than doubled your investment.

Within the FOREX market, triangular arbitrage is a specific trading strategy that involves three currencies, their correlation, and any discrepancy in their parity rates. Thus, there are no arbitrage opportunities when dealing with just two currencies in a single market. Their fluctuations are simply the trading range of their exchange rate.