Safety Through Forex Hedging
Just like with the stock market, we have much risk associated with the forex market. The best strategies to use are those that also include a good backup plan. One highly popular strategy is called Forex Hedging. Through it we can mitigate risks associated with forex trading. All that want to invest need to know about hedging and how to properly use it. We can define the term in a similar way to buying insurance policies for a given position. You do this by using derivatives, which are investment instruments. By using these, a forex trader is left without a worry because losses are going to be covered.
Hedging Definition :
Forex trading involves a variety of risks ranging from low to high. To minimize the risk, the traders use a mechanism called hedging. Hedging is a financing technique through which investors tries to secure him from unusual loss. This is usually using through offsetting in which short positions are hedged with long positions. This is done to protect an investor from the movements of the prices.
How to Use Forex Hedging
A very common and easy way to hedge is to open short and long positions in any currency pair you are trading. There are dealers that will not allow you to do this. In most cases the businesses that are currently operating at international levels will practice this hedging form. When an UK company serves a large US base then the weakening of the GBP is not healthy for the company. The reason for this is the fact that the first price that will be quoted in USD is not going to be converted into as many GBP in the near future. However, a company can overcome such a situation if they opt for a long GBP position with the use of USD. This makes up for lost money. In a similar fashion if the company will lose money in forex then GBP value will fail. The effects can be countered with the profit that is earned thanks to the value increase of the US dollar. This hedging type is easily practiced with investing in options or futures contracts.
Hedging Through CFDs- Top Working Strategies :
Through hedging an investor can keep him in his ongoing investments. Unlike other investments, an investor doesn’t have to leave an investment with a loss. Below are some of the very important hedging strategies that can be used with CFD:
Strategy # 1- Sole Share:
This important strategy involves the trading of both CFD and shares. Under such strategy, when the market situation is volatile, a share is hedged with a CFD. For example, let’s say you have 500 shares of an airline company whose flights are affected due to the Mother Nature. Currently, the total value of per share is $2, and you are concerned about the value and position of the share. By using this strategy, you hedge your share with CFD rather than going for selling it. As a result, you hedge your 500 shares with CFD at the same price on which you bought it. If sooner or later the price of your share increases from $2 to $2.50, you will make a profit of $250. If you still believe the price of your share will grow further, you have the option of cancelling the CFD position. On the other hand, if the price of share drops to $1.50, you will bear a loss. However, the loss will already be settled of by your offsetting profit.
Strategy # 2- Trading in Pairs:
Trading in pairs involves the trading between CFD of similar industries. In such cases, you purchase CFD from one company and then exchange or rather sell it with the CFD of other companies. Usually, in such a condition, one CFD generates profit while other bears losses. This is because the movement and direction of both the CFD are in the same direction. When investors follow this scheme, they buy one CFD from a company that has a strong position in the market and sells it to the bottom level of the company. This way, they bear less loss as compare to sell it elsewhere.
Strategy # 3- Diversion of Index
Another way of minimizing risk through hedging is the use of index diversion. To do so, and investor tries to diversify the investments of his accounts. This is done through the hedging mechanism. This scheme is not very popular among investors, but it still does its job.
Any futures contract is basically an agreement through which a currency is going to be exchange with another at a date that is predefined with the use of the closing time price noticed. Traders are going to sell and buy currency futures just like trading stocks. In order to hedge against a volatile currency exchange rate you will want to use currency futures.
Hedging in forex trading :
edging in the world of forex is related to having an offset position with an existing position to eliminate the risk. Hence, hedging is a way to protect against a decline in any currency. Individual traders and financial institutions utilize this technique to offset the risk.
An exchange rate risk is involved when business exports and import goods. For instance, if the government of the U.K plans to import TVs from the Japan, it will bear the loss if the yen is stronger than Pound. In this situation, the U.K government will buy the Yen from the international market and will hedge the risk of exchange risk.
Impact of leverage
A small amount of margin can be used for hedging if the leveraged is being offered by the forex market. For instance, one only requires around $2,000 of margin for the 50:1 leverage on a contract of $100,000. Traders usually have to submit more margin if the position moves against them. However, if the position is against the hedger, which shows the level of their profit is higher.
The Disadvantages of Forex Hedging
A lot of retail traders love hedging while others do not understand why they are used. There is a huge debate going on as to why one would use it. There is a price associated with hedging so you need to always make sure that the benefits that you gain are worth the effort. Through hedging you just gain protection and there is no profit. Risk is not eliminated. It is only reduced. Even if nothing goes wrong the hedge needs to be paid.
Here you can see example from Zulutrade autotrading platform where a lot of signal providers (forex expert traders) make headging forex signals.
Zulutrade signal providers closed trade report :
As you see strategy is this :
1) Trader create one sell or buy trade based on daily or weekly chart. IT is trade where profit is 200 pips or 500 pips or 1000 pips. It is LONG trade signal which duration can be weeks and months. This trade will use TREND strategy.
2) Using pivot points and Fibonacci lelvels trader create headging trade with short duration. Duration will be few hours or few days.This trade will use breakout strategy (for example RSI 15 min. chart).
We can see here BUY ORDER as “Longterm Trend strategy” (160 pips profit) and SELL ORDER “Short term Breakout Strategy” (14 pips profit).