Research Risk and Trading Plans · Forwards Trading Guide
Notional size is one view of risk. A forward portfolio also needs limits for sensitivity, maturity, counterparty concentration and cash requirements.
Start with the objective
A commercial hedge aims to manage a defined exposure, while a directional trade deliberately accepts market risk. The performance test should reflect that difference. An importer’s hedge should be assessed with the invoice cost it protects. Judging it only by the derivative profit can encourage abandoning protection precisely when the underlying currency move benefits the business.
Translate size into a scenario
For a simplified EUR/USD exposure, a $0.05 adverse move per euro on EUR 200,000 creates a $10,000 undiscounted change before costs. This illustrates one sensitivity, not a maximum possible loss. Remaining maturity, rates, spreads and contract terms can alter the valuation. An early exit instruction may not guarantee execution at the assumed level.
Use several complementary limits
Set authorised amounts, maturities, hedge ratios, counterparty concentrations and available liquidity. Aggregate positions that share the same underlying risk, even if booked through different dealers. Two trades that appear offsetting may still create separate settlement or collateral needs. Review both gross obligations and valid net exposures rather than allowing one total to conceal operational demands.
Report performance consistently
Separate realised cash results, unrealised valuation changes, funding costs and fees. For hedges, report the combined commercial outcome and residual risk against the chosen objective. For trading, state the capital or funding basis used to calculate returns and include drawdowns. A return divided by a tiny initial payment can exaggerate economic performance because a forward can begin with little upfront cash.
Try it yourself
A simplified stress limit allows $15,000 of loss from a $0.06 adverse move per euro. What euro amount corresponds to that scenario before other adjustments?
Show the worked answer
EUR 250,000, calculated as $15,000 divided by $0.06 per euro. This is a scenario based ceiling, not a recommendation or a guaranteed loss limit.
Further reading
- CFA Institute: Currency management
- CFA Institute: Forward contracts and varying maturities
- ISDA: Collateral operational practices
Educational material. Numerical examples are hypothetical and exclude costs unless stated. Forward contracts create binding obligations and may require collateral or credit approval. Actual terms, access and risks depend on the agreement and jurisdiction.
