You have probably read about professional traders hedging their forex trades and wondered what exactly that means and how it is done. Most traders do not understand how to hedge or do not see the benefits of it and dismiss hedging altogether. You are likely to come across more uneducated traders claiming that hedging is counter-productive or lacks positive impacts than those who understand hedging.
When you trade your own money in your own forex trading account then you need to make your own decisions on what you think is the proper way to trade currencies. As history shows, the majority of forex traders fail at trading and there is only a small minority which enjoys the proper success. Here at PaxForex we will give you the minority point of view and way of trading so that you can join the group which learns how to trade properly.
Here are the two schools of thought on hedging your forex traders:
The uneducated masses claim it is terrible to hedge and lacks any benefits. The first thing you may read about is paying twice the spreads. Here at PaxForex you enjoy very tight spreads and often your combined spread between your initial position and your hedge is still lower than other brokers single spread.
The educated minority which understands the benefits of hedging, how to hedge and when to hedge. A hedge comes in play when you initial position is at a loss and your analysis did not call for a breakout or breakdown of the chart formation. It is almost impossible to time an entry properly and a hedge can not only limit the negative impacts of a wrong entry, but also add to overall profitability.
Here are 4ways to hedge your forex trades:
Perfect Hedge – This occurs when you hedge the same currency pair with the same lot size. You should never open two positions in the same currency pair going in the opposite direction at the same time as this defeats the purpose of a hedge. An example would be that you open a EURUSD short position at 1.3600 for 0.25 lots. This currency pair breaks out and rallies further which will cause you to open a long position at 1.3700 also for 0.25 lots. Many traders refer to this as ‘stopping the bleeding’ as no matter which direction the trade goes you stopped losing capital. Let’s say that this currency pair is now approaching another resistance level at 1.3850. You can break your hedge which means closing the buy position for 150 pips in profits. This will temporarily increase your floating trading loss, but during the reversal you will reduce your losses and may be able to close this trade for an overall profit.
Staggered Hedge – Using the same example as above, a staggered hedge happens when you have your initial EURUSD short position at 1.3600 for 0.25 lots and now hedge at three different levels with different lot sizes. For Example you buy 0.05 lots at 1.3650, 0.10 lots at 1.3700 and 0.10 lots at 1.3750. This will give you more flexibility in managing your trade.
Hedge Using Different Currency Pair – Some traders like to hedge their open forex positions with a different currency pair. One example would be shorting the EURUSD and after the trade records losses buying the GBPUSD.
Hedge Using Options – Some forex traders like to hedge their open positions using option contracts or binary option contracts. This can be done in a low cost manner, but be aware that option contracts expiry and this is a more complex way of trading not suitable for most forex traders as you need to also understand option trading.
One of the most difficult aspects of hedging is breaking the hedge as it will temporarily increase floating trading losses which is why many shy away from learning how to hedge properly. Hedging is a vital tool for every successful trader and understanding why to hedge, how to hedge and when to hedge can greatly increase your success while misuse of hedging can be very dangerous.