Forex Hedging

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How to Protect Your Profits With Forex Hedging Strategy

Forex hedging strategies are used by some traders to protect their profits against possible reversals while leaving the original trade open. Other traders avoid it because they think it will be too complicated. But that does not have to be true. Foreign exchange hedging tactics are not necessarily so difficult. First let’s see what exactly is forex hedge trading.

What Is Forex Hedging?
A hedging trade is a kind of insurance that will pay out if things go against your main trade. It can be entered into either right away at the same time as the original trade is opened, or later. The benefit of opening the second trade later is to protect profits already gained.

Assuming that your main position is in the spot forex market, the secondary or opposing trade may be in the same market or another. It could be another spot transaction either in the same currency pair or in a different but related currency pair. It could also be in another market, such as forex derivatives, that is, options or futures. Forex options is the most popular choice.

How To Hedge A Forex Trade?
The first step when considering a forex hedging transaction is to analyze the risk of the original trade. It is unlikely that a retail trader would try to hedge every trade, but only those that involved unusual risk, for example a position size much greater than usual, or one where the risk changed for some reason since the trade was opened, or a mistake was made when taking out the original position.

Once the risk is known, we would subtract our risk tolerance, probably the amount of risk that we are used to dealing with in forex trading. Of course in some cases, where the trade is already in profit, it is possible to reduce the risk to zero. Otherwise the difference between risk and tolerance is the amount of risk that we need to balance out with the hedging trade.

Then we can look at the various possible strategies, including closing out part of the trade if in profit, or opening a transaction in derivatives. Decide on the strategy after considering all of the options, and act.

After a second position has been opened, it is very important to continue to monitor the markets. The situation will be constantly changing and it may be possible to close one trade, both, or parts of both at a time when you can maximize profits beyond the original plan. However, if you are making decisions on the fly, be careful not to allow the risk to increase.

Using forex hedge strategies does require more analysis than general forex trading. Paper trading a few hedging positions is recommended because this will help you to understand the range of possibilities and how they work. Once in the live market, decisions have to be taken carefully without either rushing or wasting time. This is not a strategy for currency trading beginners but forex hedging has its place in the toolkit of an expert trader.

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