What Do Forex Hedge Funds Do?

Summary: This page discusses how forex hedge funds work and how they make their money.

The content on this page has been influenced by a little insider knowledge. A close friend of the author started working in telephone sales for a hedge fund company recently. They have three funds and all operate in the foreign exchange markets.

To save any potential embarrassment, the name of the company, the funds and the country in which they are located will not be divulged. However, from his descriptions, it does seem as though their operation is quite standard.

So what do they do?

As might be expected, they refuse to tell anyone their secret method for profits. However, much can be gleaned from the broad descriptions they provide. Firstly, they use computer technology very heavily. This suggests that they use an algorithm to make their trading decisions. This is quite normal in the hedge fund world and very normal in the forex world.

The computer has preset conditions which trigger a trade and trades are only made when the conditions are met in full. How these trades are chosen will depend upon the risk profile of the fund and the perceived risk of the trade.

My friend tells me that they have three funds. Many companies do this. They are generically, lower risk, medium risk and highest risk. Of course, this is a forex hedge fund, so their idea of 'low' risk will be most normal investors idea of very high risk. Everything is relative!

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As might be expected from these descriptions, the lowest risk fund makes the least number of trades and holds the positions for the longest period of time. He tells me the fund is up by around 20% in H1 2011. Not bad.

The medium risk fund trades more frequently and holds the positions for only a few days. He tells me that this fund is up around 35% in H1 2011.

The highest risk fund apparently makes around 20 trades per day. This sounds as though it is an arbitration type of operation where trades are made with almost opposing positions at the same time to take part in very small mispricings within the market. This fund is apparently up by over 100% in H1 2011.

Needless to say, whatever the risk profile of the clients, they all want to be in the most aggressive of the three funds...

A fund like this - and most other currency related trading strategies - will most probably be trading currency pairs. This means that they trade the moving rate between two currencies (for example the euro and the US dollar). As that rate moves, money is made and lost around the world.

The types of factors that influence the rate of a pair are relative to each other and include inflation, interest rates, economic outlook, GDP growth and the respective current accounts. In other words, it is not simple to forecast how rates will move.

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The thing that they have learned most acutely at the fund is actually about human nature. As mentioned above, when potential clients hear about the recent performance numbers, they all want to invest all of their money in the highest performing and highest risk fund. It really does not matter just how unsuitable for them this might be, that is what they want and demand.

This level of greed is human nature and we all suffer from it. However, for good financial planning reasons, we all need to overcome it where possible. If possible...

In the same way, there are a number of automated "forex robots" that can be purchased online to trade for you. The overall concept is that the program can make profits without the need to learn how to trade, what, when and why. And amazingly, these wealth creation machines are available from only $29. Once again, this plays on the unlimited greed that exists within many of us. Caveat emptor.

Should you plan to invest in any high risk fund or opportunity, a hedge fund, in forex, or wherever, be sure to consider very carefully the real impact to your family and lifestyle that losing all of the money would have. If you do not like the consequences that you imagine in your mind, it may be wise to reconsider the investment.

If you would like to read more about hedge funds, please follow these links:

How Do You Define A Hedge Fund?

What Are The Best Hedge Funds?

How Do You Conduct Hedge Fund Due Diligence?

Is There Any Regulation Of Hedge Funds?

Why Invest In A Hedge Fund Of Funds?

How Do Real Estate Hedge Funds Work?

How Risky Are Energy Hedge Funds?

How Can You Learn About Offshore Hedge Funds?

What Can Commodity Hedge Funds Trade?