Hedging Strategies In Forex Trading
One way that can be done to limit risk is by hedging. Here are some practical examples of hedging strategies in forex trading.
In forex trading, the level of risk that may occur is always changing. There is no sure way to estimate the movement of a currency pair in the future. One way we can do is to limit the risks to protect our trading position or commonly called hedging (hedging). There are several ways used to protect trading positions, but the rationale is the same and simple.
When you have a buy position on a currency pair, you must open a sell position to protect your position, or reduce the risk if the price moves down. In the same way, you open a buy position if your starting position sells.
Here are two methods that are commonly used in forex trading:
Simple Hedging Method
If you are just trying to hedge, you can practice in a simple way. This method is sometimes referred to as direct hedging (direct hedging). This happens when you have a buy position and a sell position on a currency pair. For example, you are trading on EUR / USD pair by starting to open buy position at 1.3000 price, but after a while then price movement start to fall. Then you open a sell position, for example at the price of 1.2800.
If from the next analysis of price movements you estimate will decrease, then you can close the position of buy with the result of loss, and let the position of sell that most likely will generate profits. But if you’re not sure which way the price will move, you can leave both positions open until there is a definite signal.You can also add a stop loss level to either or both of these positions.
The difficulty that is often experienced in this way is when the price movement is uncertain we will be difficult to determine which position we will close first.If both positions have been hit (the price has already reached both levels of the hedging) then we will definitely loss the distance of pip hedging we have open.In the example above our pip hedging is 1.3000-1.2800 = 200 pips.
Trading On Multiple Currency Pairs
Because there are brokers that forbid using simple hedging methods as above in accordance with regulatory rules, then traders use the solution by trading on several currency pairs that have correlation. For example if you open a buy position on EUR / USD pair and a while later the price starts to move down.You can reopen the buy position on the USD / CHF pair because from historical data USD / CHF has a negative correlation to EUR / USD.
If USD is stronger against all major currencies, then EUR / USD will decline and USD / CHF will rise. You can cut loss buy position on EUR / USD and let the position of USD / CHF is likely to profit. In addition to opening a buy position on USD / CHF, as an alternative you can also open a sell position on the GBP / USD pair because of historical data GBP / USD has a positive correlation to EUR / USD. If USD strengthens, you can cut loss of buy EUR / USD position and let sell position GBP / USD with most likely will profit.
The weakness of this hedging is that the correlation relationship between currency pairs is not linear, a time the correlation can be strong and can sometimes weaken. However with hedging at least you can protect your trading position by minimizing losses.