How to Hedge when Trading Forex

October 5, 2015

Throughout my career as a Forex trader I have come across the word 'hedge' or 'hedging' numerous times. Quite I often I hear traders ask 'does broker XYZ allow hedging?' These traders are usually referring to if a broker allows a trading account to hold both long and short positions of the same asset at the same time. I have also heard the term used quite differently. In this post I will give some insight into hedging and explain how I hedge my trades when trading Forex and CFDs.

 

What is hedging?

 

Traditionally, hedging was widely used by longer term stock and commodity traders and investors and was used to reduce risk and potential loss. If a trader or investor purchased a particular stock or commodity with the plan to hold for several weeks, months or years, they could reduce the risk of the position by hedging the position. Hedging would allow profit to be made if the purchased asset did not go in the desired direction, these profits were usually made through purchasing options or short selling a particular stock and would go against the loss of the original long asset purchase. For example, a trader may go long Barclays stock, he or she could then hedge the trade by purchasing put options for Barclays, short selling highly correlated shares (other banking shares etc.) or a mixture of both. If Barclays shares plummet while owning the shares, any major loss could be covered by the held options or short sold stock.

 

 

Do you need to Hedge when Day and Swing Trading Forex?

 

You may not need to hedge all positions when day and swing trading Forex. Most traders won't hedge at all, but you should! If your broker offers guaranteed stops then this is your best form of 'hedge'. Using a guaranteed stop can reduce and limit risk. When I have access to guaranteed stops there is no need to hedge my positions, but guaranteed stops are not always offered or not always available.

 

How I Hedge my Forex Trades?

 

When guaranteed stops are not an option I will hedge my trades for 2 reasons...

 

1. There will be major influential news announced while I hold the position

 

I have seen price jump 30, 40, 50 and even 100 pips at a time. With the whole SNB CHF incident, price moved considerably more than this. If price moves against your position with such momentum, do not expect your tight stop loss to trigger at your desired price. Hedging trades when such price movements are expected is very wise. My video below will show you how I do this.

 

2. I will likely hold the position over the weekend close

 

Just as price can move 100's of pips in a split second when economic news is announced, the Forex markets can also gap or re-open by 100's of pips at a time. You will need to protect your trading account against such movements. Learn how I hedge my Forex trades for market gaps in my video below.

 

 

 

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