Hedge or hedging is the method professional traders will use to protect their position in certain currency pairs. Sometimes, the prices of currency pairs in the forex market will change in abrupt movements, and it can happen in an instant. This might be because of certain economic news that might affect the prices of certain currencies in a big way, or it might also happen because of any other reasons.
The fluctuating prices of certain currency pairs can affect your profit potential, and when the currency price movements become fluctuating, traders are at a risk of losses. Thus, it’s important for them to protect their position using the method called hedging. However, hedging has its own limits, and it can only protect the trader’s position for a short time.
Two Different Hedging Strategies You Can Apply in Forex
There are two hedging strategies traders can apply in the forex market, and these strategies have different implications for their forex assets. Forex traders can activate the hedge for their trading position when they think that the prices of their currency pair assets will have a significant change soon. Both hedging strategies can help traders protect their currency pair assets and minimize the risk of losses that they have. Here are the two different hedging strategies you can apply in forex:
- Perfect hedge. The perfect hedge strategy is the hedging strategy that will take both the short and the long-term position for the currency pairs you are holding, which will help you minimize the risks of losses for your currency pair assets. Aside from minimizing the risks of losses, this hedging strategy can also eliminate your potential profits for the assets you are holding in forex. You can only use this strategy for a short period, and it requires you to put quite a massive investment to use this strategy.
- Imperfect hedge. The imperfect hedge strategy is the hedging strategy you can use to protect part of your forex investment by using put options in forex. Put options give you the right to sell a currency pair for a specified price, and by doing that, you can minimize the risks of losses for certain currency pairs when their prices fluctuate and become unpredictable. It is a short-term strategy, and you can only get a limited protection from this strategy. However, you don’t need to put in a massive investment when you use this strategy.
What are the Risks of Using Hedging in Forex?
Hedging is the strategy in forex that allows you to protect your investments from losses for a short period. However, using the hedging strategy itself is something that will give you certain risks. For forex traders, hedging can give them a certain protection for the assets that they have in the forex market, but the protection they get from hedging will always be temporary. There is no certainty at all that guarantees the hedging strategy will work in every situation. Here are some risks of using hedge in forex:
- Additional investment needed to activate the hedging strategy. The hedging strategy you are using in forex will require you to add some more investment into your forex account, and you will have the risk of losing both your additional investment and your primary investment with the hedging strategy.
- Some fluctuating price movements can get worse, and even the perfect hedge strategy won’t work in this situation. The perfect hedging strategy might promise you to protect your forex assets for a short period, but when the price movements get worse for a long period, even the perfect hedging strategy won’t be able to protect you from losses.
- Imperfect hedge can only provide limited protection for a brief period. By using the imperfect hedge strategy, you don’t need to add a massive investment to your account. However, this is the strategy that will only protect you for a temporary period, and it can only provide you with some limited protections. This strategy won’t be able to protect your investment when things go wrong later.
- Hedging strategies won’t work for big world events that have continuous effects in certain currencies. Again, hedging strategies in forex can only protect your investment in a short period, and it can’t protect your forex assets if there are some big world events that cause the continuous effects in certain currency pairs. For this situation, hedging will only act as a flimsy protection for your forex assets.
Tips to Use Hedge in Forex Trading
It’s best for you to use hedging in forex trading only when you think you can handle the current price situation for your currency pairs. Don’t use hedging in forex trading for every situation that involves sudden price changes in the currency pairs you are holding. Here are some tips to use hedge in forex trading:
- Use hedging as the last resort to protect your investment. You shouldn’t use hedging in a way that is wasteful. Hedge is only useful when there is a potential of sudden price changes in the currency pairs you are holding. It doesn’t mean that you can use it any time.
- Assess the situation before activating the hedge strategy. You need to analyze the current situation, such as world events, how the media affects certain currency prices, economic situation in certain countries, and so on, before deciding on using the hedging strategy. Using the hedging strategy in forex can be expensive, so you need to assess the situation before using any hedging strategy to protect your forex investment.
- Get prepared for the worst. Hedging strategies don’t always work well, no matter how you trust in them. So, always get prepared for the worst, meaning that you should always be ready for the worst outcome you will get when you use any hedging strategy in the forex market.
Conclusion
You have learned about what hedge means in forex and how you can take advantage of the different hedging strategies. In the forex market, hedging becomes an important strategy you can apply when things get a little rough for the currency pairs you are holding. However, it’s also important for you to keep in mind about the risks of using hedging and its limitations in protecting your forex investment. Good luck!
