Hedging Strategy For Profit in Forex Trading, Myth Or Fact?
The main function of hedging strategy is to minimize risk. But by ensuring the following 5 points, a hedging strategy can bring in profit trading
Have you ever tried a hedging strategy? This method is often a favorite alternative for traders who are reluctant to cut loss. They argue that hedging needs to be done to minimize losses. But apparently, not a few traders who use hedging strategies to bring in profit trading. If the nature of a hedging strategy is a protective risk, is it really possible to do so?
To get an answer, let us first look at some of the factors supporting the success of the following hedging strategies:
1. Situations Trigger Hedging Strategy
Many traders call hedging strategies are advanced trading techniques. However consciously or not, most beginners have done hedging impulsively. For example when they are ‘curious’ with orders that can not profit, most will open a new position to pursue prices that run in the opposite direction of the first order.
On the other hand, experienced traders do hedging as a planned strategy. They are not motivated to hunt for profit trading or want to prove themselves. For trader pro, hedging strategy is part of a calculated Trading Plan; whether to hedge in one pair or two different pairs, whether to directly apply hedging or just open the opposite position when the first order has loss, or what lot, Stop Loss, and Take Profit specified for each order.
The planned hedging strategy will obviously be maximized in order to (at least) secure trading from large losses. If already experienced and accustomed to anticipate the movement of the market, a trader can even formulate a hedging strategy that brings profit trading.
Meanwhile, novice traders who do hedging because of entangled emotions, more risky acting rash. They do not analyze price volatility, and often get stuck when hedging positions are locked. Confusion to decide which positions can be removed and defended began to burst, so often they ended up letting the position continue to float, or even end the hedging without a logical basis.
To clarify your understanding, here are examples of planned and unplanned hedging strategies:
A. Planned Hedging Strategy
Let’s say the EUR / USD is currently at 1.20000. You do open buy and sell with the same lot at that level. A day later, the price dropped to 1.19500. When looking at the oscillator, the price is at oversold level and there are some bullish reversal signs from the Price Action reading.
To secure a sell position that is already profitable, you can close it, then let the buy position to welcome a bullish reversal chance. When the price then actually goes up, you can already make profit when the new price up to the level of 1.19530. How can? The position of your buy is a loss of 70 points or 7 pips, but your sell order is profit trading 500 points or 50 pips. That means you have a profit of 43 pips.
In this scenario, there are 3 actions you can choose:
- Closes the buy position at the 1.19530 level and gains 43 pips.
- Close the buy order at breakeven level (1.20000) and get 50 pips profit.
- Close the buy order above 1.20000 to be able to achieve higher trading profit.
In the end, all of the above hedging scenarios can be profitable. Of course there is a risk of price reversing down before it actually touches the targeted level. Therefore, an understanding of the power of trend is needed here, so you do not set the target of trading profits too far.
The strategies and indicators used also do not have to be the same as the above example, which uses the oscillator and Price Action to see the reversal signal. It’s a good idea to use a proven system based on your own trading experience and understanding.
B. Unplanned Hedging Strategy
You see an opportunity of rising prices when EUR / USD touched 1.20000. Shortly thereafter, a buy order was opened to gain profit from the forecast. When the price actually goes down to the 1.19500 level, you panic and feel the previous analysis has gone wrong. You also open a sell order at that level, but the next price goes up at 1.19530.
In such a locked position, your buy and sell positions suffer loss equally. Since it’s all done without plans and analysis, you do not know whether to keep them open, close one of those positions, or end them?
The scenario looks like this:
Two positions are left open: If the price rises, the floating loss from the sell position will continue to grow, while the new buy position will breakeven if the price touches 1.20000 again. While you’re waiting for the possibility of having the highest probability, hedging positions that have been exposed to twice the spread can be burdened again by the swap interest.
- Closing one of the positions: You have to really know which position to close, and at which level the order should be close. If the calculation is lacking in one aspect, then you can actually close the wrong position. Given the previous hedging action has been done without a plan, then the closure of positions were most likely not taken into account properly.
- Say when the price is at 1.19530, you are still uncertain whether the price has bounced and can move up further, because previously it has been so let down by the price drop to 50 pips. The actual upside movement is preceded by an oversold signal and the Bullish Reversal Price Action is only seen as a correction in your eyes. So in the end, which closed just open buy. When the price shot up to 1.20000, your losses are clearly doubled; about -7 pips from buy position, plus -50 pips from sell order. It has not been accumulated with spreads and (possibly) negative swaps.
2. Understanding Hedging Strategies
Even if you are already planning to trade with a hedging strategy, you still need to deepen your understanding of hedging strategies. The above situation is not always the case, because there are times when the trading signal slips and you lose twice.
In addition, the planned hedging strategy mostly has a rule that is not simple, especially if it involves the placement of entry based on Pending Order, lot calculation, also measurement of Stop Loss and Take Profit. Here is an example of a planned ‘simple’ hedging strategy scheme:
Are you confused? If not, then congratulations! Because you are already on the right track to learn a hedging strategy. But if you are not too understand, then you should learn again to know the intricacies of planned hedging strategy.
In addition, any calculations and decisions in a hedging strategy should be performed with a cool head and taken with the objective as possible. This is a test for newcomer traders, because they are usually difficult to think rationally, when trading positions are still locked and both floating loss.
3. Knowledge of Hedging Risk
Although the planned hedging strategy can be managed in such a way as to generate profit trading, the original essence remains to protect trading from major loss risk. In preparing a hedging plan, you need to know how to minimize risks with a hedging strategy first, before attempting to earn more trading profits.
Why is that? If you observe once again, the basic concept of hedging that opens 2 opposite positions at one time will simply end up break even. Unless you use a different lot, or deliberately open a position at a level that is not the same, then the assumption is still valid. Many people consider hedging strategies more risky, because you will be subject to spread 2 times.
If so, then why is hedging still done? Those who are fond of a well-planned hedging strategy have their own ways of differentiating lot size and entry installs, Stop Loss, and Take Profit.
If you look at the hedging strategy scheme above that is considered easy, it appears that the Sell Stop order is set with a lot larger than the Buy position: Sell Stop opened with 0.3 lot, while Buy is loaded 0.1 lot. Comparison of Stop Loss and Take Profit between the two positions is determined in the same level, ie 1: 2 (30 pips: 60 pips). This indicates that the trader using the strategy is more confident of the downside projection after the price has broken through the Sell Stop entry target.
4. Type of Hedging Strategy
After knowing the hedging understanding, the next step is to apply the right kind of strategy. You need to know, hedging strategy consists of various types, there is one pair hedging, hedging correlation pair, and so forth. Each type has advantages and disadvantages that can be tailored to your understanding and risk tolerance.
For example, hedging a pair can be done more easily, because you do not need to look for correlation, perform additional analysis for the other pair, or anticipate the spread difference between the pair. However, the tendency to be locked in a ‘breakeven position’ will be greater, and there are some brokers that limit the freedom of one pair hedging.
On the other hand, coupled correlation hedging can be a solution to the limitations imposed by broker policies. In addition, you can get a larger hedging difference. However, the way pair heading correlation is more complicated than one pair hedging, because you need to find the best correlation, perform analysis in (at least) two pairs, and be able to overcome the risk of spread and swap gaps between the two pairs.
The use of the right type of hedging strategy is very important, because you will not get any results if you impose a hedging way that does not fit your understanding.
5. Broker Support
One last aspect that is not less important is the condition and specification of the broker. To be able to process a planned hedging strategy that can bring in trading profits, of course, is needed support services from brokers.
It’s useless to plan your hedging strategy one pair, if it turns out the broker you use does not allow such techniques. Fortunately, there are more brokers currently allowing rather than banning hedging. Those who do not allow hedging are usually regulated brokers in the US, because they are constrained by NFA rules that do not allow it.
However, you need to pay attention to the broker’s terms under certain conditions. This is because there are forex brokers who allow hedging for trading under normal conditions, but prohibit it when clients follow certain bonus programs, contests, or broker promos.
In addition to broker rules, some other broker specifications that need to be considered are:
- Strict spreads, to minimize trading costs from hedging positions.
- Trading platform, because there are certain platforms, such as MetaTrader 5 that can not be used for hedging one pair. MT5 can only facilitate hedging if the broker activates it in hedging mode instead of netting.
- Execution of orders, to ensure the smoothness of hedging strategies as planned. If the broker is often late to execute the order, also often impose slippage and requote, then how well hedging any way will not bring the desired trading profit.
From the above reviews, it can be concluded that a hedging strategy that earns a profit can be a myth if:
- Done without planning.
- Not familiar with the mechanism.
- Do not put risk protection first.
- Incorrectly apply this type of hedging strategy.
- Conducted in a broker whose conditions do not support hedging.
On the other hand, a hedging strategy that brings profit trading can be a fact if:
- Done with a plan.
- Already understood the ins and outs.
- Know and prioritize risk factors.
- Applied with the right kind.
- Relying on optimal broker support for hedging.
So actually, a hedging profit strategy that is a myth or a fact is in your own hands. The key is to use the above aspects as parameters, then make sure that everything is met.