This Indian rupee-based example shows how any currency trader can mitigate inflation risk by hedging using a security that profits from the drop in the underlying currency’s value.
Forex traders in India are well aware of the benefits of trading in a volatile market, especially their own currency. Many of them have also been reaping the rewards of shorting this bearish environment. However, living in India can be expensive, especially as food and energy inflation has diminished the buying power of the rupee. In fact, as I write this article, the rupee has reached a new all-time low against the US dollar.
So, while traders may be making profits, they will have to work extra hard to realize gains if they do not properly hedge against the falling rupee. Even if they made profits in the 2011, they lost about 18% of purchasing power when compared to the US dollar.
On January 1, 2011, I could buy only 45.45 rupee for one dollar. Now, you can get 54.07 rupee for one dollar. Beginning in August, the rupee began a sharp weakening trend.
The chart below shows the strength of the US dollar to the rupee.
It’s a good lesson on how any currency trader can mitigate their risk of inflation in that currency when trading it. What can be done to combat your exposure to inflation? Learn to hedge your portfolio by trading something that profits from the drop of rupee value.
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