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.
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. 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.
Using Hedging strategies, means opening two inverse positions on a given security of the same amount, you will almost eliminate any risk. In fact, it does not really matter the trend or the observed volatility, since your balance will remain stable no matter what.
You must be asking yourself what is the real advantage of Hedging in this case. This strategy should be used preferably when we want to protect the profit already made on a position, but we have doubts about the evolution of the course of the asset on the short term.
It is therefore enough to wait for the beginning of a reliable trend to resell the position that has become obsolete and thus be able to keep the position that is moving in the right direction open.
Corrective movements are relatively common in the world of online stock investment. It is therefore interesting to take advantage of them by using a strategy that combines long positions and short positions such as Hedging.
In this case, just take a long position on an asset, and give a reverse position order on the course that you think could have a possible technical correction, and therefore will be less than your goal in the long run. This way, if the course of the asset that you are following turns into a corrective trend before your goal, you will be able to make profits on your short term position while maintaining your long-term position.
This method is particularly interesting, but it requires that you know precisely how to identify the levels likely to have a reversal on its trend thanks to pivot points, support and resistances.
If you use the strategy of hedging to trade on the stock market through CFDs or future type contracts, you will always do so to protect your positions by taking two opposite positions. But it is essential to also look at your investment goal for which you opted in your initial position. Depending on the case, we can use a “short hedging” or a “long hedging” strategy depending if it is short or long.
The short hedging will be used by investors with active positions that they have to sell on the market. In this case, the new purchase position will be used to maintain its presence on the market in case the movement continues while pocketing the profits generated by the previous short position.
Long hedging will be used by investors who are not yet positioned on the market and wish to take a long-term position. It will be therefore protected while waiting for the most opportune moment to take a long-term position to buy and to sale.
Should you favour a hedging strategy over classic speculation?
As we have just examined in detail, hedging is a strategy that is above all used by traders to effectively protect their capital. In fact, hedging is not one of the most profitable trading strategies; the profits are generally less significant. However the principal advantage of this strategy is that it provides more frequent profits than with a more profitable strategy. It is therefore less risky.
Using classic speculative methods on financial markets is generally more profitable than using a hedging strategy. However and in proportion to the number of transactions completed, it should be noted that the success rate is not as high. Clearly traditional speculation offers a significant profit against risk ratio but you will have less winning transactions than by using a hedging strategy.
A hedging strategy for its part is considered to be more conservative. However the fact of applying this strategy enables you to attain a better success rate than with traditional speculative investment as the number of positions closed with a profit is higher. We can therefore consider hedging to be a strategy that offers a middling profit to loss ratio but with a higher success rate.
To conclude, if you are still wondering if you should use a hedging strategy then the answer to your question will above all depend on the type of investor you believe yourself to be. If you have a strong aversion to risk then this strategy would be ideal for you but if you are attracted to significant profits then you will probably prefer more traditional speculative investment strategies.
To assist you in deciding if you are going to implement a hedging strategy on your future positions or not here is a complete summary of the different advantages of this strategy:
Now that you know the major advantages of a hedging strategy let us examine the major disadvantages and weak points, here is a detailed list:
Generally speaking and in regard to the different advantages and disadvantages of a hedging strategy we can conclude by stating that this is of course not a miracle strategy that will guarantee profits with online trading but it still remains a guarantee of limiting potential losses in case of a negative fluctuation in the rate of the underlying asset upon which you have based your investment. It is best here therefore to evaluate the necessity of using this strategy in accordance with the risk estimated on your long term position or to choose a partial or complete hedging strategy depending on the individual case. Finally, it should again be noted that the choice of implementing such a strategy depends greatly on your risk aversion. It is therefore up to you to decide based on your preferences and objectives.
Now that you have understood the benefits of hedging strategies, you will be able to test it online by subscribing to a quality Forex trading platform. You will be able to cover your positions.