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Understanding Hedging in Forex Trading
Written by: PaxForex analytics dept - Friday, 02 February 2018 0 comments
In most industries, in order to limit the risk of loss, you should buy insurance. This applies to the financial markets as well, but in order to avoid the insurance fees, the hedging technique has been developed. Traders of the financial markets, small or big, private or institutional, investing or speculative, all try to find ways to limit the risk and increase the probabilities of winning. There are many forex trading strategies out there and hedging strategies is one of them.
Having a deep understanding of the money markets is what allows most traders to make continuous trading profits, however when they couple their knowledge of the money markets with a very well thought out trading strategy that can also reduce the risk of making a loss. With that in mind you may be wondering if there is any way you can minimize your chance of making a loss when placing forex trades. There are of course lots of different forex trading strategies you may be interested in adopting, however one which does appeal to a lot of traders is something known as a hedging strategy.
In the forex markets, there are many hedging possibilities that can arise although it is often widely misunderstood by many. For most traders, they see hedging as taking a long and a short position in a currency pair simultaneously. The purpose of this kind of trading is to ensure that
the trader makes a profit regardless of the market movement. However, there is much more to hedging than merely taking a long and short position.
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. The way a simple forex hedge protects you is that it allows you to trade the opposite direction of your initial trade without having to close that initial trade.
Hedging is not difficult to learn, but newcomers in forex world should beware of this approach. This is due to their personal safety, because to tell you the truth, hedging is not for everybody, especially for beginners in the field. In order to properly hedge your risk exposure, you need to have a good timing. In other words, your entry level is quite important so you need to make the best out of your price action reading skills. One of the most important things to keep in mind is that hedging requires a lot of flexibility. As you grow as a trader and gain more experience you can become better at this type of trading activity.