Last Updated on September 1, 2020 by Jason Wilson
Although most trading strategies applicable to the Forex are aimed above all at making large profits, certain strategies have the unique aim of enabling you to cover certain other existing positions to limit your possible losses. This is the case for the strategy named Hedging which consists of using a precise method of buying and selling currency pairs by covering riskier positions. Here are some explanations that will help you better understand this technique.
What is the strategy of Hedging on the Forex?
As we have just noted in the introduction, the strategy of Hedging on the Forex is not aimed directly at making profits by taking position on a currency pair, but rather at taking certain positions for covering others.
The use of this method offers the advantage of being both simple and rapid and therefore accessible to all traders, even total novices. To summarise, once you have taken position on a currency pair that you wish to cover in case of a drop in its rate, you take an inverse position over the short term for the same amount as that of your first position. Thereby, if a drop occurs in the rate of your main pair, you will have the possibility of recovering part of the points lost due to your inversed position.
However, the Hedging strategy can go much further as you can use it simultaneously on several pairs. As an example, imagine that you take position on the USD/JPY on the rise. You can then use an asset that is inversely correlated to the dollar to cover this first position. Oil or gold would be an example of a good choice in this situation for Hedging.
The advantages of using a Hedging strategy on the Forex:
There are of course other methods that enable the covering of positions on the Forex, but Hedging offers a number of advantages. One of them being that this strategy helps you to avoid acting impulsively to an inversion of the trend by closing your position too early and so missing certain opportunities.
On the Forex this technique is particularly recommended due to the low cost of transaction fees or spreads applied to the currencies. Selling your covering position will therefore not be very expensive.
Finally, it is particularly advantageous to benefit from this method of covering your positions when you invest on the foreign exchange market and you wish to increase your profits over long positions.
The few disadvantages of Hedging applicable to the Forex:
Of course, and as with any investment strategy, Hedging doesn’t offer only a plus side. It is therefore necessary that you have a large enough investment capital available to enable you to open several positions at the same time, without forgetting the margin applied by your broker that you need to include in your calculations.
If you carry out the correct calculations these spreads on one or another of your positions will be the only losses that you will experience.