Forex hedging is utilized as a valuable strategy to fully protect the profits of traders, in order to ensure that no possible reversals can occur when the original trade is still open. There are traders who avoid this strategy due to a misconception of it being too difficult or complicated, but that is not the case. Foreign exchange hedging strategies are fairly straightforward and can be incredibly useful maneuvers to take when dealing with foreign exchanges.
What is a Hedge Exactly?
Hedging trades are a type of insurance which pay out when affecting external factors work against your primary trade. This negotiation can be entered as soon as the original trade opens or anytime afterwards, depending on personal preference or capability—though certain benefits of opening the second trade afterward include protection of profits that have already been gained.
Even if you hold a primary position in the spot forex market, it is unwise to presume that all secondary and/or opposing trade will not ever be in the exact same market or a similar one. One possible reason for this potential occurrence is that another spot transaction may be in either the same currency pair or in a closely correlated, though different, currency pair. Another explanation is the possibility of it residing in another market altogether. One such market is forex derivatives, otherwise known as options or futures, thought forex options is the more popular of the two.
How To Hedge A Forex Trade
Firstly, when considering forex hedging transactions, one must carefully and thoroughly scrutinize the possible risk factor the original trade presents. Although it is highly improbable that a trader would attempt to hedge every trade, they are most likely to try for those that involve an unusual amount of risk. There are several possible examples of this: a trade which involves a position size much larger than the norm, one whose risk factor greatly changed one way or another since the trade was initially opened, or perhaps an instance when a mistake occurred while the original position was taking place.
After knowing the risk factor, you can calculate what your risk tolerance is and subtract it from your final product—although it will probably be an amount forex trading is used to seeing. In some cases, the risk amount can be reduced to zero. If the trade is already in profit, then the risk can be completely reduced to zero. If this is not the case, the trader can then take the difference of the risk and the tolerance to uncover the maximum amount of risk he or she needs in order to balance out evenly with their hedging trade.
After this is determined, you can study several possible strategies, and after considering all possible options, choose one and act. Various amounts of strategies include opening a transaction in derivatives, or closing out a portion of a trade if it is profitable. If the former strategy is performed, it is extremely imperative that continuation of monitoring the markets is exercised, since constant change will occur, and opportunities of closing a certain trade, or a portion of that trade, will present themselves. If this happens, proceed carefully. Profits can benefit even beyond what you originally planned on, however the potential risk might increase as well.
Since hedge strategies do require a bit more study and analysis than the general kind of forex trading, paper trading a few of these hedging positions is highly suggested. In this way, you will have the opportunity to completely understand the wide range of possible opportunities, how they work, and how they could affect you in the long run. This kind of strategy will prove itself as a vital skill for you, once you are in the live market, and making serious decisions which require time and careful thought. Though an uncommon strategy choice for currency trading beginners, forex hedging is incredibly helpful for the experienced and innovative trader.