How does Forex Hedging Offset Your Risk?
When you turn yourself into a forex broker, the risk is inevitable. However, with the risk, there are substantial profits too. Wouldn’t it be great if you could offset your unwanted risk and don’t go bankrupt? Well, you can do that with the forex hedging strategy.
Forex hedging can minimize your loss from trading. However, having a deep understanding of forex trading is needed to try hedging in forex. You may find many ways of hedging from the experts, but only a very few works for all. What are those?
With that in mind, the following is the step-by-step guide to enlighten you about hedging and how you can do it for forex trading.
First, let’s get the idea of hedging.
What is Hedging in Forex?
It is a strategy to save from a potential loss that may occur due to the market’s adverse move. However, it is short-term protection. If a trader gets any information about upcoming economic info that may trigger the currency market, the trader may opt for hedging. It is usually done by ordering the opposite position of the same currency pair. However, a trader may go for different approaches according to the news and risk level.
Although it reduces the risk but has never been a strategy to make money as unwanted exchange rate movement cannot put you at a loss if you take the proper forex hedging strategy.
Example of Forex Hedging
Hedging is complicated, so understanding it might be difficult even for the experts. An example would make you understand ins and out.
If a bank from the USA is going to bring some profit from Europe, it may hedge a part of profit via an option. It is because the expected transaction is set to sell in euro and buy the US dollar, so the bank would buy through the put option to sell the euro. Buying through the put option, the bank locks the transaction at the worst rate for the upcoming trading, which will be the strike price.
The Importance of Hedging in Forex
For positive portfolio management, forex hedging is an unsung hero. Hedging is essential to cover the changing investment landscape. However, it may help a trader in three ways,
Diversify the investment
The globalization of forex trading causes the transaction’s increased allocation across the boundaries, which eventually increases the associated risk. So, it is natural that the investors may want to diversify the investments while reducing any unwanted loss in their portfolio. In that case, a hedge can be the best friend for the investor, as it is what the investors need most to offset the currency loss.
Uncertain political conditions are another reason for currency fluctuation, which ultimately increases the risk. So, whenever any political unrest appears, a trader can apply the hedging position to cover the potential loss.
Economic uncertainty may affect adversely as well as positively. So, economic uncertainty brings the 50-50 chance. The volatility in the forex market may give you the experience of an overall crisis, and hedging could be an important part of the transaction to keep you safe from such uncertainties.
The Forex Hedging Strategy You Need to Know
You cannot earn Forex hedging expertise overnight. You need to have enough experience to forecast any relevant uncertainties that may lead you to hedge. As you gain the experience, you can apply many hedging strategies. However, there are three known strategies everyone tries to get the ultimate success. Let’s get to know them.
Simple forex hedging strategy
It involves opening an opposite of the current trade. Such as, if you already opened a long position, you may open a short position of that currency pair, which is normally known as direct hedging too.
However, the net profit for direct hedging is zero as the original position also remains open for the reverse trend. But, if you close the trade without hedging, it would put you at a loss. On the other hand, if you decide to hedge, it will be able to make money for you through the second trade. It is because the market goes against your first position.
However, some forex hedging broker don’t allow direct hedging, so you should compare the brokers via forex broker reviews to the broker that allows simple hedging.
Multiple currencies hedging
Multiple currency hedging strategies involve two positively correlated currency pairs. For example, GBP/USD and EUR/USD are positively correlated, and if you take the position on both pairs but through the opposite direction, a multiple currency hedging occurs.
So, how does it exactly work?
Suppose you have opened up an order for a short position on EUR/USD, but you want to hedge the USD exposure. For that, you will need to open a long position for GBP/USD. If the euro falls against the dollar, your long position will take the loss, which is GBP/USD. On the other hand, this loss will be mitigated through the profit of your EUR/USD position. Besides, if the US dollar fall, your hedge will rescue any loss from the short position.
You will have to keep in mind that hedging multiple currencies comes with risk too. Moreover, if the forex hedging strategy works, your risk gets reduced, and it may earn profit for you too. On the other hand, if the hedge fails, you may face loss for multiple currencies.
Forex options hedging strategy
Usually, a currency option provides the opportunity not to trade before an expiry time. Options are a popular FX hedging strategies as the trader can reduce the exposure by paying for the option’s cost.
For example, you have opened up a long position for AUD/USD pairs and open the position for $ 0.76. But you are expecting a decline on the pairs and placed the put option at $0.75 with a month worth expiry. However, if the price has gone under $0.75 during the expiry, you will face the loss for the long position, but your option hedging would balance the exposure.
On the other hand, if AUD/USD is raised, you could wait for expiry or your option and would pay the premium only.
Forex Hedging Techniques
Forex hedging is tricky; even the expert traders may find it difficult to hedge. However, in-depth expertise is needed for hedging operations. But new traders can go for hedging too, but we suggest they try with the demo account through the forex hedging broker. However, it is always better to create your own forex hedging techniques and apply them while practicing hedging.
One of the working techniques is selecting the currency pair, but it depends on the trader. According to the experts, choosing the major currencies can get you the opportunity to access more hedging options than a minor currency.
On the other hand, the market’s volatility depends on the liquidity of currency pairs. So, before applying any hedging in FX, you should check everything on a currency-by-currency basis.
However, monitoring the market for a long time and the capital you also have necessary.
How can you Start Forex Hedging?
There is no specific training to start hedging in FX, but you can follow the forex hedging techniques we have mentioned above. However, trying with a risk-free environment through the demo account is also a good idea to start hedging.
If you just opened the live account, you should not go for hedging, as you need to observe the market to understand it and follow the news and information regarding the market. But, brokers also play a big role, so you may look for the best forex broker that offers to hedge as a limited number of brokers allows hedging in FX.
Hedging with the Help of Robot
With the invention of forex robots and tools, now hedging can be done via robots, and many forex hedging broker offer robots for their clients. With the robot, you don’t need to collect all the historical data manually. Instead, the robot will do for you and help to choose your fx hedging strategies.
You need to set up the command, and the robot will open several positions for you for buying and selling currency pairs at the same time.
Reverse a Forex Hedging
Sometimes, you may need to undo a position due to some forecast. So, if you don’t cancel the hedge, you may face a loss. In that scenario, placing a stop-loss will undo the hedge as well as canceling the hedge can undo the process.
But the forex hedging broker will have to allow you to do that; some brokers may not allow it.
Forex Hedging Fees and Costs
Cost and fees entirely depend on the broker. Policies may vary on different brokers as well as the fees. But the spreads and commissions are must payable, but the amount depends on the situation and the trading instrument. Swap fees can also be included if you hold the position after 5 pm.
Although forex hedging can save you from any potential loss, it is a psychological satisfaction for the retail trader as hedging strategies can make you feel that forex is not all about losing the money.
However, you need to understand the FX hedging strategies to take the measurable steps about the trading. Apart from saving you from the loss, hedging can get you to profit too.
If you follow all the things explained in this article, you can really offset your trading risk.