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Trading forex with hedging
Written by: PaxForex analytics dept - Saturday, 26 April 2014 0 comments
One of the ways to protect your account when trading forex is to use the hedging trading technic. A transaction implemented by a forex trader to protect an existing or anticipated position from an unwanted move in exchange rates is called a forex hedge. Think of a hedge as getting insurance on your trade. Hedging is a way to reduce the amount of loss you would incur if something unexpected happened.
There are many techniques used to hedge a position, but the logic behind is simple. When you are in a long position in a specific currency pair you will take another position that would protect your trade should the currency pair move downward. Thus you limit the downside risk of your initial position. In the same way if you are in a short position you take on another position to protect your trade from upward risk.
Another way of hedging is by using different currency pairs. For example you could go long EUR/USD and long USD/CHF. In this case it wouldn’t be exact, but you would be hedging your USD exposure. The only issue with hedging this way is you are exposed to fluctuations in the EUR and the CHF. This means if the Euro becomes a strong currency against all other currencies, there could be a fluctuation in EUR/USD that is not counter acted in USD/CHF.
Some brokers allow you to place trades that are direct hedges. Direct hedging is when you are allowed to place a trade that buys a currency pair and then at the same time you can place a trade to sell the same pair. While the net profit
is zero while you have both trades open, you can make more money without incurring additional risk if you time the market just right.
For example you are long on EURUSD at 1.30 and it started to move against you. What you can do is open a short position in the EURUSD at perhaps 1.28. If you think the exchange rate is in a downtrend you can close the long position at a loss and let the short position run at a profit. Even though hedging sounds like the greatest thing that ever happened to trading you have to remember that it involves risks of its own.