Hedging in Forex is an advanced investment strategy that lets you create a buffer against unstable market conditions.
There are various ways to hedge in the forex market, but their efficiency depends on how skilled you are as a trader.
Ranging from simple to complex, hedging in Forex aims to keep your position when trading in the opposite direction in the same market.
Here, we discuss the fundamentals of this strategy and a few different strategies for holding your position.
The Basics of Hedging
Hedging allows you to protect your position in a currency pair. This maneuver allows for short-term security when you have concerns that the Forex market may experience a sudden, unexpected hit. Working in a volatile global system that operates 24 hours a day requires the need for protection.
Hedging strategies will allow you to offset the risks of fluctuating prices by keeping additional positions open as a defense mechanism.
There is no way to eliminate risk in the market, but hedging provides a safer alternative when trading. If prices move against your expectations, keeping that counter position open will maintain some level of security.
Forex Hedging Types
There are various strategies for hedging in Forex, but here we will cover three of the most common. Deciding which strategy to use will depend on your broker policy and experience level.
Simple Forex, also referred to as direct hedging, is one of the most basic strategies. Simple Forex allows you to retain your position, so you do not have to close it in the event of a loss.
You open a direct channel to buy on one currency pair, then open the same position to sell the original currency pair.
This more complex strategy involves trading in multiple currency pairs. There are variations on how you can use this strategy, but one way is to buy a long position and a short position in the same currency, aiming for an offset.
Another way is to hold a buying position with two positively correlated pairs, so one will go upward as the other moves downward.
Forex Options come with a greater risk than simple and multiple currency strategies. This setup is an agreement between traders to exchange at a specific price point for purchasing options.
You can close out the position at the initial price point if it continues to drop beyond your expectation. This tactic minimizes the losses to only the premium of the purchasing price.
Costs of Forex Hedging
You will not incur any fees alone, but your broker may require commission or payout to the market where you are trading.
You may also have to pay for keeping positions open while swapping, so it is vital to pay close attention not only to the market but to the stipulations of your strategies.
Is Hedging in Forex Worth It?
Any trader can accomplish hedging in Forex, but it is essential to weigh out the benefits and losses of each individual exchange. Hedging strategies minimize your chances of significant loss and over-exposure in the market, but no trade is entirely risk-free.