Learn Hedging in the Foreign Exchange Market

Hedging is applied to forex trading in its fundamental form. Hedging is a strategy that shields you from losing a part of your investment in a specific market position. There are various kinds of hedging strategies. It could be very easy, and it could be very difficult depending upon your experience level. But if you are a beginner you can do a simple one, and if you are an advanced trader, then you can choose the difficult one.

Basics of Hedging

Hedging is not always appreciated and allowed by every type of broker. That is why you should always check whether the broker is permitting hedging or not. Most of the traders use hedging to protect themselves from any adverse market conditions. It is quite common to see at the time of market volatility when the market fluctuations are pretty unpredictable.

Hedging is generally used more in the forex market compared to other markets. It is because of the volatility of the forex market, which is quite higher than many other financial markets. As a trader, you can use different types of hedging techniques to save your position in the market.

Forex Hedging Strategies

There are several hedging strategies depending upon the complexity. Here you will learn about some most common hedging strategies that you can use based on the broker policy and your experience level.

1. Simple Forex Hedging

Simple forex hedging is also known as direct hedging. It is the easiest hedging technique to understand and the widely used hedging strategy of all. It happens when you decide to open a position by buying one currency pair ( (or go long). And then you open the same position by selling that currency pair (go short).

There could be various reasons behind this. At this time, you have two open positions in the opposite direction. Through this method, you keep your original position, although you do not make any profit on the hedge. It means there is no need to close your original position in case of loss, despite strategies you can make money by going short. If you maintain the original position, then it could profit you when the market trend reverses.

2. Multiple Currency Hedging

Multiple currency hedging is a complicated hedging technique. This strategy will be beneficial for you if you are trading in various currency pairs. This occurs when you take a long position and also take a short position in one of those currencies.

For example, you take a long position in the EUR/USD market, and a short position in the USD/GBP market. Here, you are safe against your USD vulnerability to a high degree. Although multiple hedging strategies do not include fluctuations in the other currencies in which you are vulnerable. In this example, if EUR or GBP will fluctuate, you will still be vulnerable.

Another variant of multiple hedging strategies also shows traders who take short and long positions in currencies are positively coordinated. It means that if one currency pair goes up, the other will go down. So, if you are willing to buy positions in one currency pair and sell positions in another currency pair, then they should balance. It is not a simple strategy as a simple direct hedge.

3. Forex Options Hedging

Option in the forex market works the same as the options in other financial markets, which is a kind of agreement to exchange at a certain price in the upcoming future. A forex option is a common asset that is used by forex traders to hedge their position. But this, not perfect hedging because still, it can cause you some losses.

For example, You have gone long on GBP/USD at $1.12 by expecting that the price of the pair will go high. Due to some upcoming economic data release, you are concerned about the price of this pair. To reduce this risk, you put an option with a price of something around $1.11 and the expiration date of the option far off the data release.

So in such conditions, if the pair goes lower, then the trader will be paid out on their option depending on the conditions of the contract set. If the news does not come out, then the currency pair will continue to go higher, and the trader can hold their position.

Bottom Line

Now, you can decide whether hedging is in your favor or not. The advantage of using one of the hedging strategies mentioned above is that you can limit some of your vulnerabilities in the markets in which you are trading. When the right time comes, hedging can put you in a very positive and profitable position.