Usually, there may be ups and downs in every business. If you are a forex trader, the risk is an essential aspect to consider. There are always currency changes in the world, and there is a wide range of trading opportunities available to you as a forex trader. Forex Hedging strategy is a common way to face price fluctuations as well as reduce unwanted exposure to currencies from other positions. Hedging forex strategy is an operation by opening an additional position strategically to protect against adverse moments or at risk in the Forex market.
If we discuss this in detail, hedging is a process of buying or selling financial instruments to balance the current position. This can reduce the risk of exposure. Traders find various ways to limit the risk which comes from exposure—from that, hedging in one strategy. If a trader has a good knowledge of money markets, they can make continuous trading profits. When this knowledge enhances with the hedging forex strategy, it leads to reduce the risk of loss.
How to do?
When traders hedge their trade, they place more than one trade with any two currencies they have paired. There are some circumstances when that is going to make financially feasible. Usually, hedging strategies used by more advanced traders. Because it needs in-depth financial market knowledge to apply hedging forex strategies, new traders also can use this if they have a good understanding of the forex market, and they need to create a trading plan.
The most crucial step of starting hedge forex is selecting a forex pair to trade. Even though this can do as per your preference, choosing a major currency pair may provide more options. Volatility depends on the liquidity of the currency pair. So the trader should make hedging decisions on a currency-by-currency basis.
Another consideration of using hedging strategy is the amount of capital you have since opening a new position requires more money. And also the time you spend on monitoring the markets.
- Read More 8 Reasons FOREX Traders Lose Money
Types of Hedging Forex Strategies.
Hedging forex strategies are most common in risk management strategies which use in forex trading. There are various types of hedging strategies, and the following are three main types.
Simple Forex hedging strategy
In this strategy, traders open the opposing position to current trade, which is also known as a direct hedge. When the net profit of direct hedge is zero, you keep the original position in the market until the trend reverses. If you don’t hedge the position, it means that your trading is accepting any loss. In the other hand, if you decide to hedge, it will enable you to make money with a second trade as the market moves against you.
Multiple currency hedging strategies
This is a common hedging strategy on selecting two currency pairs that positively correlated. As an example, it can be EUR/USD and GBP/USD. Then take positions on both pairs in the opposite direction. But hedging more than one currency pair comes with its own risk.
If you have good knowledge of that, it can achieve success. If your hedging strategy works, your risk will reduce, and you can make profits.
Even though it can have zero net balance in the direct hedge, in this strategy, one position may generate more profit than other position makes in the loss. But in certain cases, if it doesn’t work, there may be losses from multiple positions.
Forex Options Hedging Strategy
Multiple currency options don’t give the obligation to exchange the currency pair at a given price before the expiry time. But in here, forex options strategy gives the chance to reduce your exposure while only paying for the cost of the option.
As an example, you have opened your position at $0.76 in long on AUD/USD currency pair. You decide to hedge the risk by putting the option at $0.75 with one-month expiry. If the price falls below $0.75 at the time of expiry, you will have a loss on your long position. But your option may be in the money and balance your exposure. If the AUD/USD pair rise, you can let your option expire and pay only the premium.
Benefits of hedging strategy
Main use if this is protecting forex traders from exchange rate fluctuations. Hedging strategy can help to mitigate the loss or limit it to a known amount.
If someone thinks that forex pair value is going to decline, while the trend is eventually reversing, then hedging helps to reduce short term losses. And protect long term profits.
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