Forex hedging

Forex hedging is when someone trading in currency enters into a trade with the intention of safeguarding an anticipated or existing position from an undesired shift in the foreign currency exchange rates. By properly using a forex hedge, a trader that is short on a foreign currency pair can protect themselves from upside risk, and conversely, a trader that is long will be able to protect themselves from downside risk.

Simply explained, hedging is nothing more than protecting your investment in the case of something bad happening. A good way to understand hedging is to compare it to health insurance. You have protection in case something happens to you, but it will not prevent something bad from happening to you. If something does happen, however, you will be much better off than if you didn't have the insurance.

There are two primary methods of hedging currency trades available to the retail forex trader. Spot contracts is the first and in essence are the regular kind of trade made by such a trader. They have a short term delivery date of two days, making spot contracts a less effective vehicle for hedging. Rather than used as a hedge itself, a regular spot contract is normally why a hedge is needed. The more popular hedging alternative is foreign currency options. Similar to other securities trading, the purchaser has the right to sell or buy the currency pair at a specific exchange rate at some point in the future without the obligation of actually having to buy or sell. To restrict the potential loss of a given trade, regular options strategies such as long straddles or long strangles can be applied.

Making money in the forex market using hedging strategies can be tricky, but can also be profitable if done correctly. To make money, the forex trader will safely invest in two opposing positions at the same time. One position will likely lose money, while the other will provide a profit. While the profit may have been higher if the right trade was the only one invested in, the danger of losing a large sum of money will also be averted. Having a good forex broker can help in the forex trading process, especially when it comes to hedging. Having a broker that is reliable, can provide low spreads and leverage, and has easily accessible resources and tools can be invaluable to any trader employing hedging as an investment strategy.

Read more: Forex Hedging - The Hedged Grid System