Hedging

Another section we can explore in regards to Forex is the use of hedging strategies. Hedging is very specialized trading strategy that not every trader utilizes yet it is easily done and just requires the knowledge to execute the trades and can be very useful.

To hedge is to be long and short in the same currency pair at the same time, it can be a perfect hedge so the same number of lots are traded on both sides or can be done in a ratio. For example, if a trader buys one lot of EUR/USD and then sells one lot of EUR/USD/JPY at the same time theoretically he will have a perfect hedge, yet this will not be the case as they will be crossing the spread (difference between the bid and ask price) and will have a small locked in loss immediately. In other words, any price movement in the currency pair up, down or even sideways would not influence the profit/loss on the trade.

This strategy seems illogical yet this can be effective in price spikes, news or similar instances whereas the markets move quickly. In addition in most cases you will only be paying margin on one side or a reduced margin on the other side and therefore less equity is required to keep the second position open.

In addition this strategy can also be used in a ratio, which means the trader may buy or sell more of one side of the currency pair and therefore is protecting themselves from outright one sided positions, this reduces the profit potential on the trade yet reduces the outright risk as well.

In addition if you holding a longer term position in a currency pair and you are close to a margin call due to a spike in the short term, you could hedge and lock in your losses. In this case you would still have your original position open while also being able to maintain your position, due to the opposite trade. In this case you may be under the margin close out, and if the market returns to its original state before the spike you can close out the second (hedge) trade and your original long term trade will still stand.