Hedging, or reciprocal trading, is a hedging measure for an opened position in the market, to protect against movements that go against expectations. Hedging is often the most commonly used by investors in the stock market and effective hedging tools in this market are derivative securities products such as futures or options. In forex, hedging is considered a favorite hedging tool for many professional traders, but in general, the rest of them do not know or understand this tool well.
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So, what exactly is hedging? How to do and should hedging in forex trading or not? All will be answered in the next content of the article.
For example: You want to open a Buy order on the EUR/USD pair. To hedge this position, you open a Buy order on the USD/JPY pair, because these two pairs have a correlation coefficient of -83. Or a Sell EUR/CAD order would be a hedging strategy for a Buy USD/CAD position because the correlation coefficient between these two pairs is +91.
The situations that occur you can argue are similar to the direct hedging strategy.
Hedging strategy with options contracts.
The method of implementation is quite similar to the method of hedging by options on the stock market presented in the first part. Here, we will take more examples of hedging in forex trading to make it easier for you to understand.
For example: You Buy the EUR/USD pair at 1.17543, to hedge this position, you buy a EUR/USD Put Option with a strike price of 1.16700. If the EUR/USD rate increases as expected, you close the original Buy order to lock in profits and have the right not to exercise the option. On the contrary, if the EUR/USD rate falls sharply, you are entitled to sell this currency pair at the price agreed in the contract, of course the original Buy order will lose but the risk has been offset from the profit of the Right. Select Sell. In both cases, it will cost you a fee to buy the Option.
The option hedging strategy is implemented with the following reciprocal positions:
Open a Buy forex order, hedging with a Buy Put or Sell Buy position. Open a Sell forex order, hedging with a Buy Put or Sell position.
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In fact, most forex brokers allow traders to hedging according to the second strategy, the other 2 strategies are less. In particular, only a very small number of forex broker offers options, so the third hedging strategy is the least likely.
Should hedging in forex?
The answer is definitely yes, because hedging can help you reduce your risk when the market is volatile. But, only hedging with its true purpose and nature. Do not abuse and use “unconsciously”.
Usually, an investor does hedging when they cannot close a trade for some reason and their main purpose is still to hedge the risk of this trade. If they are lucky, they will have the opportunity to increase their profits or at least partially offset the risks.
Besides, there are many people who abuse this tool and buy-Sell transactions chaotically, we temporarily call it “unconscious hedging”. When placing a Buy order, the price has just gone down, then immediately enter the corresponding Sell order, when the Sell order has just made a profit, it starts to close the order, but when the order is closed, the price continues to decrease, making the original Buy order lose a lot. more, then enter another Sell order. Placing so many orders continuously is not actually hedging but only makes them lose more transaction costs.
You must know, all hedging strategies are not free. The price you have to pay when hedging is making your transaction costs increase by placing more orders or having to spend money to buy hedging tools such as options, futures…. If hedging is effective, profits can cover those costs, otherwise, you will lose more.
Therefore, we only encourage you to hedging in case you have a good trading system, because of an event that the market can fluctuate and affect these trades, then, new hedging makes sense and maximizes its effectiveness.
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Of course, hedging can still be a tool to increase profits, but it only really works for professional and experienced traders. For new traders, you should use hedging for its intended purpose.
Through what we have shared in this article, hopefully you have understood a bit about hedging and how to effectively use hedging strategies in forex. A good trading system, a suitable hedging strategy will help you effectively deal with large fluctuations from this market.