Forex hedging introduces the approach of opening multiple positions simultaneously. Traders use this technique to offset Forex trading risk, as the FX market is often affected by a variety of adverse conditions, especially during market uncertainty.
This is why investors seek extra tools to protect open positions by purchasing or selling extra assets to minimize the risk of potential exposure. In this article, we will explain how Forex exchange hedging works. Additionally, we will revise some major FX hedging strategies.
The idea of any Forex hedging strategy relies on opening one or several positions to oppose the direction of the current trend. It lets traders achieve a net-zero balance or get as close to it as possible. Generally, most investors would rather close a position and re-enter the market under more favorable conditions. Forex hedging makes it possible to leave the first position open while making another move simultaneously.
In simpler words, the approach makes it possible to protect open positions of an underlying currency pair against potentially negative market moves. Traders must always track different events and news that may result in extreme FX volatility. This awareness can be the fundamental aspect of building effective short-term protection.
Forex hedging comes in two similar approaches:
The first method looks more flexible and more predictable in terms of risk management. It has proved to be better protection in case of markets moving against you.
Now, let’s have a closer look at types of Forex exchange hedging and how they work. We can divide all major FX hedging strategies into two major categories.
Depending on the online Forex broker, traders are likely to have a chance and place direct hedge transactions. It means you are allowed to place several deals using a single asset, for example, USD/GBP. What’s more, you will probably be able to go short on the same currency pair simultaneously.
As a result, you will have zero net profit. However, if you have the tools to time the FX market accurately, you can make some profit without the extra risk involved.
A complex methodology offers to choose two assets that correlate in the most favorable manner. For example, major currency pairs such as EUR/USD and GBP/USD might be a good combination. The next step is to take positions in opposite directions for both currency pairs. If one of any currencies declines, you will still compensate for losses with a short position.
The most challenging part here is to accurately close positions no matter if you apply a direct or complex Forex hedging strategy. If you decide to keep the first position open, you must close the second one. If you are eager to close the hedge from both ends, it is vital to take action simultaneously. Otherwise, you will lose due to a sudden gap.
So, to ensure proper strategy execution, you need to find the perfect moment to close the position. If a trader overlooks any of his or her open positions, the entire Forex hedging strategy will be doomed to failure.
Now, it is time we reviewed some of the most popular FX hedging strategies. We will discuss 3 major options that are popular with investors:
Forex hedging is mainly used to lock the price of an asset in an agreement between a buyer and seller. It helps to protect traders from markets moving against them. Market participants can choose from several FX strategies and approaches with fixed buy and sell obligations or less compulsory conditions with a chance to customize the contract.
The main benefit of the approach is the ability to keep one protected from economic recessions or survive during a bearish market.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.