5 Do's and Don'ts When Hedging for the First Time

For finance executives, managing foreign exchange (FX) risk is critical to protecting your business from the unpredictability of currency movements. Yet, hedging—especially for the first time—comes with challenges. Successful hedging requires a well-thought-out strategy tailored to your company’s specific needs, risk tolerance, and exposure to currency fluctuations.

While some mistakes are common for first-timers, so are proven best practices that can set the foundation for effective FX risk management. Below, we’ll break down five things you should NOT do when hedging for the first time and five things you SHOULD do to maximise your chances of success.

5 Things Not to Do When Starting to Hedge

1. Basing Decisions on the Current Rate Level Instead of Your Risks

It’s tempting to make hedging decisions based on favourable exchange rates. However, this approach often leads to reactive strategies that don’t address the underlying risk. For example, if your business has limited risk due to natural hedges in your operations (e.g., revenues and expenses in the same currency), over-hedging to "lock in a good rate" could be unnecessary and costly.

Instead, focus on identifying your actual FX risks and hedging to mitigate those exposures, regardless of market conditions.

2. Justifying Hedging with a Market View

Hedging is about reducing risk, not about predicting where the market is heading. If your decision to hedge is based solely on your expectations for currency movements, you’re speculating, not hedging.

For instance, if you think the GBP/USD rate is going to depreciate and choose to hedge simply because of that belief, you could leave your business exposed should the rate move in the opposite direction. Keep your hedging strategy disciplined and avoid making speculative bets.

3. Not Comparing Hedging Costs to Potential FX Risks

Hedging comes with costs, from transaction fees to opportunity costs. Many first-timers overlook these costs or fail to weigh them against the potential financial impact of FX risks on their business.

For example, paying a high premium for an option that provides minimal protection may not be worth it. Always calculate and compare costs relative to the potential risks and decide if the hedge is worth implementing.

Conversely, don't let hedging costs sway away from considering hedging - it is all about comparing these costs to how much currencies could move.  For example, hedging many G10 currencies for several months costs a fraction of a percent and can protect from currency swings that can potentially exceed several percent.

4. Hedging Too Much or Too Little

Finding the right balance is crucial. Hedging too much can expose your business to unnecessary costs, while hedging too little leaves your business vulnerable to currency swings.

A common mistake is attempting to hedge every single transaction. Instead, focus on your key exposures - such as large contracts or regular currency flows—and use those as a starting point for your hedging programme.

5. Forgetting About Your Hedges

Hedging isn’t a set-it-and-forget-it approach. Forgetting to monitor and manage your hedges can lead to mismatched coverage or missed opportunities to optimise your strategy.

For instance, if your cashflows change or if market conditions shift significantly, your existing hedges may no longer align with your financial goals. Keep an eye on your portfolio and adjust as needed.

5 Things to Do When Starting to Hedge

1. Set Clear and Quantifiable Hedging Objectives

Start by identifying what you’re trying to achieve with your hedging programme. Are you looking to stabilise cash flows, preserve margins, or protect against large currency swings? Defining clear and measurable objectives ensures your hedging strategy stays aligned with your business goals.

For example, a good objective might be to "hedge 70% of our projected USD revenues for the next 12 months to ensure no more than a 5% deviation from budget."

2. Periodically Review Hedging Needs

Markets are dynamic, and so is your business. Changes in operations, sales projections, or market conditions may require updates to your hedging programme. Establish a regular schedule - monthly or quarterly - to review your forecasted cashflows and FX exposures.

This review process allows you to identify additional risk areas, fine-tune coverage, and ensure your strategy remains effective over time.

3. Compare Prices from Two or More Providers

Don’t settle for the first quote you receive. Different hedging providers - banks, brokers, or fintech firms - offer varying rates and products. Comparing pricing and terms ensures you’re getting the best deal.

For example, shop around to find competitive pricing on forward contracts or options while ensuring the provider offers robust support and execution capabilities. Remember that lower fees shouldn’t come at the expense of service quality.

4. Align Hedges with Projected Cashflows

Effective hedging matches the size, timing, and currency of your hedges with your anticipated cashflows. When your exposures and hedges are synchronised, you can better protect your bottom line without creating unnecessary risks.

For example, if you expect a €500,000 payment in six months, a six-month forward contract for the same amount would hedge that exposure effectively. Misaligned hedges, however, could result in over-coverage or liquidity challenges.

5. Gradually Ramp Up Hedging While Fine-Tuning the Process

Avoid implementing your entire hedging programme in one go. Start small with limited coverage, evaluate the results, and refine your strategy before scaling up further.

This phased approach allows you to identify what works, learn from mistakes, and ensure your process runs smoothly. For example, you might begin by hedging 20% of your monthly exposures and increase gradually as you grow confident in your strategy.

Take the First Step Towards Effective Hedging

Hedging for the first time requires a careful balance of strategy, discipline, and flexibility. By avoiding common mistakes and applying proven best practices, you can build an FX risk management programme that stabilises your cashflows and protects your business from currency volatility.

Remember, hedging is not a one-size-fits-all solution. Each organisation has unique needs, and your strategy should reflect your business's specific goals and risks. If you're ready to explore how effective hedging can transform your financial operations, reach out to an FX risk management advisor or leverage industry-leading tools to get started.

Visit our FX & Treasury Academy and consider using the FX Risk Management module by HedgeFlows!