Should small businesses get into hedging?

Many months of continued economic and political turmoil in the global economy has led to highly volatile currency markets. This has impacted everybody in various diverse lines of business but particularly badly hit have been some organisations conducting business across borders. Where big conglomerates are dealing in volumes that are able to bear this burden, such shifts in currency may make the difference between profitability and bankruptcy for small to medium enterprises (SMEs) such as import-export companies, farmers, jewellery retailers and other small businesses.

The first thing to do is delve into the process of hedging, the benefits and how to put a hedging strategy in place, all the while giving a broad overview of hedging, before delving into the specifics and potential forex and commodities trading tactics that can be employed to positive effect by small businesses.

Firstly, let’s put the current situation into context. Events in the global economy over the past few years have led to significant volatility in the currency markets, which has subsequently affected the profitability of many companies doing cross-border business.  Currency volatility has become a particularly critical issue, not only in the struggling euro zone, to businesses such as import companies that are purchasing goods or services from overseas in one currency and selling at a later date in their local currency. Business leaders that do not address the issue of currency fluctuation are putting their business at risk.

The continued uncertainty that remains around the outlook for the rest of 2012 means that volatility is likely to prevail in global currency markets. Businesses, particularly SMEs, should be taking this opportunity to put strategies in place to proactively manage this issue and counter this risk.

At Alpari, a global forex and commodities broker, we are keen to use our expertise in our field to provide businesses, such as import agents, with the understanding and tools to navigate their businesses through this challenging time, by providing insight into how hedging currencies against regular commercial transactions can help mitigate risk and maintain operational profitability.

What is hedging?

Put simply, hedging involves making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, through something like a futures contract. For instance, a good example of hedging is when you own stock in a certain company; you can then enter into a futures contract stating that you will sell that stock at a set price, thereby avoiding or moderating any market fluctuations. Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the transaction fees).

In this case, for traders such as import agents, hedging is a tool that allows companies involved in cross border, international trade to protect their regular business transactions against currency and commodity price changes.

The employment of a hedging strategy allows companies negotiating deals in foreign currencies to plan for potential future mid-transaction shifts in exchange rate, by locking in the price of a product which will be delivered in the future and thus locking in margins in advance. In essence, it is like having an insurance policy against rising prices.

Hedging can be executed through several different tools, including forwards, futures, swaps, options and collars, but primarily forwards and futures.

Hedging limits risk

So what are the benefits of forex trading to SMEs and importers? Why can it be so important? Well, firstly hedging limits risk rather than creates risk. It is important to point out that although hedging is not 100 percent failsafe, with the correct guidance, it is a way of reducing risk significantly. Importers can derive tremendous value by seeking hedging opportunities through the use of forex forwards and futures.

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