Foreign Exchange Stop Loss
Exposure Management should not be undertaken without having a foreign exchange Stop-Loss policy in place. A foreign exchange Stop-Loss policy is based on the following two fundamental principles:
1. No guarantees what you plan will work as you cannot see in to the future.
2. Having a back up plan could save your business and reduce your loss.
Why have a foreign exchange stop loss policy
Stop Loss is nothing but a commitment to reverse a decision when the view is proven to be wrong. Whether an Exposure is hedged or not, it is assumed that the decision is backed by a View or Forecast, whether implicit or explicit. As such,Foreign Exchange Stop Losses should be activated when critical levels in the rate being monitored are reached, which clearly tell that the view held has been proven wrong.
The factors/ assumptions behind a view either change or are proven wrong.
The Exposure Manager should be accorded flexibility to set appropriate Stop-Losses for each trade.
The Exposure Manager should, however, make sure he has set a stop-loss for positions he enters into, on an priority basis
While Benchmarks will be based upon the Big Trend and will incorporate a certain amount of room for error, the Exposure Manager should be careful to not violate the Benchmark on the wrong side.
It is appropriate to recount here some words from a speech Dr Alan Greenspan, Chairman of the US Federal Reserve, delivered in December 1997, on the Asian financial crisis. He says,
“There is a significant bias in political systems of all varieties to substitute hope (read, wishful thinking) for possibly difficult pre-emptive policy moves. There is often denial and delay in instituting proper adjustments Reality eventually replaces hope and the cost of the delay is a more abrupt and disruptive adjustment than would have been required if action had been more preemptive.
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