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Hedging as a trading strategy for forex traders

Hedging is a strategy used by traders to protect their trading positions from adverse movements in the forex market. It is the process of buying and selling the same financial instrument to balance or offset the current position from risk exposure. Forex hedging as a trading strategy can be used in a wide variety of ways; simple, complex, or even futures. It depends on a trader’s experience and market knowledge.

The first strategy type is called a perfect hedge. In this case, traders open a long and short position on the same currency pair at the same time. This strategy allows you to open a reverse position for a currency pair without actually closing the initial position. For instance, if you buy USD/EUR currency pair then at the same time you can place a trade to sell the pair too. It is called a perfect hedge because you’re eliminating the whole risk. While the net profit when both the trades are open is also zero, you could make money from the position if you time the market right without sustaining additional risk.

Another common hedging strategy is a complex one using multiple currency pairs. A forex trader can hedge against a particular currency using two different currency pairs at once. If you’re buying USD/GBP, then you also open a short position of GBP/EUR simultaneously. Thus you would be hedging against the risk exposure of GBP. But this isn’t a perfect hedge as the price fluctuations of EUR and USD are also pertinent to your trade. This strategy helps experienced traders come up with a complicated hedge with multiple currency pairs to eliminate the risk exposure.

The third and final hedging strategy is using forex options. This is also an imperfect hedge as it doesn’t completely remove the risks involved in the trade. A forex option is an agreement to conduct a certain currency trade at a specific price in the future. For example, if you’re buying a long position of EUR/USD at 1.33, then you place a forex option at 1.32 to reduce the risk if the market moves lower.

Socio-economic and political factors make the foreign exchange market a highly volatile place. That’s why having a hedging strategy in place to diminish the risks from the sudden price movements can certainly help. Only if you have the timings and necessary market knowledge to pull it off. So try out the strategies with a practice account before risking money.

Risk Warning: This material is considered a marketing communication and does not contain, and should not be construed as containing, investment advice or an investment recommendation or, an offer of or solicitation for any transactions in financial instruments. Past performance is not a guarantee of or prediction of future performance. Trust Capital TC Ltd does not take into account your personal investment objectives or financial situation. Trust Capital TC Ltd makes no representation and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast, or other information supplied by an employee of Trust Capital TC Ltd, a third party or otherwise.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 81.48% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Trust Capital TC does not offer Contracts for Difference to residents of certain jurisdictions including the USA, Iran, and North Korea. Please consider our “Risk Disclosure“.

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