Forex Trading Hedging Strategy: Traders of the financial markets, big or small, institutional or private, speculative or investing, all of them try to find ways to limit the risk and increase the probabilities of winning. There are many Forex trading strategies out there. Hedging is one of them. In fact, hedging is one of the best strategies that are why many large institutions use it as a mandatory component. There are even investment funds that are named after this strategy, as they ‘hedge’ most of the trades that is why they are called ‘hedge funds’.
Forex Trading Hedging Strategy
In order to limit the risk of loss you should buy insurance. This applies to the financial markets too. The hedging technique has been developed in order to avoid the insurance fees,. The futures market was first founded in the 19th century to protect the traders from potential losses and price fluctuations of the agricultural commodities. To hedge means to buy and sell two different instruments at the same time or in a short period either in different markets or in just one market such as the Forex market.
Hedging is a very commonly used strategy. A trader needs to choose two positively correlated pairs like EUR/USD and GBP/USD and NZD/USD and AUD/USD and take opposite directions on both. Hedging is meant to eliminate risk loss during times of uncertainty and it does a pretty good job on that part.
But safety can’t be the only concern while trading; otherwise it would be safest not to trade at all. That’s why we use technical and fundamental analysis to make the hedge system more profitable, it is not just safe. This is where the analytical ability will help you to get a profit while you take opposite positions on correlated pairs. When deciding to hedge, a trader can employ analysis to spot two correlating pairs but that will not act exactly the same way. As they say, a picture is worth 1000 words, so let’s picture the hedging benefits and scenarios with some real events and charts that have happened in the recent past.
Forex Trading Hedging Strategy Explained
By Examining the charts above, we can see that at the starting of May both Euro and Pound were at big round levels against the Dollar, 1.40 and 1.70 respectively, which will provide resistance. With EUR/USD and GBP/USD on uptrends for more than a year, a correction or a reverse at best was late overdue. So a short on both pairs seemed justifiable at those levels. But we think it will be too much of a risk to enter 2 short positions on correlating pairs or even one if the short didn’t work out. So need to analyze which of these pairs was the weakest so we can hedge, short that one and enter long on the other.
Technically EUR/USD had made a 1,300 pip run from the bottom couple year ago, and GBP/USD had made a 2,200 pip journey. And Euro was not as strong as the Pound. This means that if the dollar strengthened, EUR/USD would fall even harder. Europe is still struggling and their data hasn’t been impressive lately, on the other side UK is running even faster, their data has been exceeding expectations and rates raise is on the agenda of BOE. This will leave us with shorting Euro, as it had the best chance to fall and if it did it would be bigger than GBP/USD. But we are not sure if it will fall, so we enter long GBP/USD, because it has a better chance of continuing up, and if it start to reverse it will be a smaller reverse than EUR/USD.
Almost at the same time, both pairs reached the apex position and started falling again. EUR/USD fell about 500 pips and GBP/USD fell about 300 pips. If we short Euro and go long Sterling with one lot each, we would have taken 5,000 USD on the first and lost 3,000 USD on the second pair, which can leave us with a 2000 USD profit. Looking at the same charts again, after completing the retrace and forming a base around 1.50 for Euro and 1.67 for Pound, we might decide to go long again.
If the same analysis applies again and we short EUR/USD and go long on GBP/USD at the starting of June. GBP/USD makes a 350 pip move to 1.7050 and EUR/USD manages only 150 pips. So 200 pips with standard lots would have made us a 2,000 USD profit. If they both started to fall, Euro which we shorted would fall even harder. Meanwhile GBP which we longed would see smaller losses too, so we would still be in profit and that is the whole point of hedging, small profits, but no losers. We can also increase the profits by increasing the size of trades.
Please note that: because of the differences in trading conditions, all the forex strategies can not be applied to all broker platforms. So, Choosing Forex broker is a vital task. We would like to recommend you HYCM Broker. This broker has all the positive trading conditions necessary for any forex strategy to work. Read HYCM Broker Review to learn more.
Forex Trading Strategies
|Lesson 1||profitable Forex trading strategies|
|Lesson 2||Most popular trading strategies|
|Lesson 3||Forex Scalping Strategy|
|Lesson 4||Forex Trading Hedging Strategy|
|Lesson 5||Forex Trading Trendline Analysis|
|Lesson 6||Forex Trading Breakout Strategy|
|Lesson 7||Pivot Point Reversal Strategy|
|Lesson 8||Pivot Point Break Out Strategy|
|Lesson 9||News Trading Strategies|
|Lesson 10||Marker Sentiment Analysis|
|Lesson 11||Pivot Points Trading Strategy|