Why Hedging Is The Best Forex Trading System

Traders of the financial markets regardless of whether they are small, private, institutional or speculative have to find a strategy through which they limit risk while increasing the probability of a good trade.

There are many strategies which can be used to achieve this and hedging is one of them. In fact, it’s the best strategy.

When a Forex trader commits to a trade with the intention of protecting an existing or anticipated position from the unknown, they are said to have initiated a Forex hedge.

Hedging is a Forex trading system, which if well utilized, protects you (the Forex trader) from downside or upside risk.

There are 2 ways through which you can hedge a currency trade; either through a spot contract or through foreign currency options.

A spot contract is essentially a regular type of trade any Forex trader makes.

They are not so effective because they have a very short term delivery rate (about 2 days).

Foreign currency options on the other hand gives the buyer the right (not obligation) to buy or sell a currency pair at a specific rate, sometime in the near future.

To limit the potential of a loss, a regular options strategy can be used. Something like the long straddle or bull spread should be able do the trick.

A Forex hedge is applied in four parts;

  1. Analyzing the risks – you (the trader) should identify all types of risk you are exposed to. After doing this, consider the implications of taking this risk unhedged.
  2. Determine risk tolerance – here, you use your risk tolerance level to determine how much of a trade’s risk position needs to be ‘covered’. How much risk are willing to take? How much are you willing to pay to eliminate that risk?
  3. Determine the strategy to be employed.
  4. Implement and monitor the strategy in use. Is it yielding positive results?

To summarize all this, hedging is not a Forex trading strategy for predicting which way a currency pair will go but rather it’s a method of using the Forex market to your advantage.

It does not matter whether you are a newbie or a guru, hedging will provide an ‘insurance policy’ for trading on the Forex market.

If you employ the right tactic you can be guaranteed that you’ll never lose on another trade again and if you do, the impact wont do much harm to your investment.

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