The primary goal of every trader is to be profitable and to limit his/her risk limit per trade. This which isn't easy and simple to be done. One way to limit risk in a trade is to hedge. Lets take a look at what hedge is and how we can hedge in forex
Hedging is simply bringing forth a way to protect yourself against big loss. Think of a hedge as getting insurance on your trade. Hedging is a way to reduce the amount of loss you would incur if something unexpected happened. Direct hedging is when you are allowed to place a trade that buys a currency pair and then at the same time you can place a trade to sell the same pair. While the net profit is zero while you have both trades open, you can make more money without incurring additional risk if you time the market just right. Hedging allows you to trade the opposite direction of your initial trade without having to close that initial trade in this way protecting your trade/s .The advantage of using the hedge is that you can keep your trade on the market and make money with a second trade that makes profit as the market moves against your first position. When you suspect the market is going to reverse and go back in your initial trades favor, you can set a stop on the hedging trade, or just close it. It works best when the two assets in question are negatively correlated as this will produce the most effective hedge and this means that forex pairs are ideal for hedging.
If executed well a hedging strategy can result in profits for both trades. What follows is a hedging strategy designed for the currency markets.The first step to implementing the hedging strategy relies on watching the market during the first hour of either the US or UK open. It is during this time that market activity is at its peak and this period often sets the tone for the rest of the day.
Examine the whole forex space and get an idea for which currencies are going up and which are going down versus the US dollar. Then, pick the currency that has fallen or risen the least, this will be your directional trade, and pick another pair that should stay relatively flat, this will be your hedge trade.
As an example, let’s say that in the first hour after the UK open the US dollar is showing a lot of strength. EURUSD is down -0.20%, GBPUSD is down -0.45%, CADUSD is down -0.40% and JPYUSD is down -0.65%.
As we can see, EURUSD is down the least so we will pick this pair as our directional trade. Because EURUSD is down the least, it is showing the most comparative strength. That means, when the market changes direction EURUSD will go higher more than the other pairs.
Now that we have chosen to buy EURUSD as our directional trade we need to pick a currency pair in which to sell EUR against in order to create a hedge. In this case since we can see that JPY is showing the most comparative weakness so a good choice would be EURJPY. Our hedge trade is therefore to buy EURUSD and go short EURJPY. Risk should be kept the same for both trades so that the profit per pip is exactly equal for both pairs.
Hedging is simply bringing forth a way to protect yourself against big loss. Think of a hedge as getting insurance on your trade. Hedging is a way to reduce the amount of loss you would incur if something unexpected happened. Direct hedging is when you are allowed to place a trade that buys a currency pair and then at the same time you can place a trade to sell the same pair. While the net profit is zero while you have both trades open, you can make more money without incurring additional risk if you time the market just right. Hedging allows you to trade the opposite direction of your initial trade without having to close that initial trade in this way protecting your trade/s .The advantage of using the hedge is that you can keep your trade on the market and make money with a second trade that makes profit as the market moves against your first position. When you suspect the market is going to reverse and go back in your initial trades favor, you can set a stop on the hedging trade, or just close it. It works best when the two assets in question are negatively correlated as this will produce the most effective hedge and this means that forex pairs are ideal for hedging.
If executed well a hedging strategy can result in profits for both trades. What follows is a hedging strategy designed for the currency markets.The first step to implementing the hedging strategy relies on watching the market during the first hour of either the US or UK open. It is during this time that market activity is at its peak and this period often sets the tone for the rest of the day.
Examine the whole forex space and get an idea for which currencies are going up and which are going down versus the US dollar. Then, pick the currency that has fallen or risen the least, this will be your directional trade, and pick another pair that should stay relatively flat, this will be your hedge trade.
As an example, let’s say that in the first hour after the UK open the US dollar is showing a lot of strength. EURUSD is down -0.20%, GBPUSD is down -0.45%, CADUSD is down -0.40% and JPYUSD is down -0.65%.
As we can see, EURUSD is down the least so we will pick this pair as our directional trade. Because EURUSD is down the least, it is showing the most comparative strength. That means, when the market changes direction EURUSD will go higher more than the other pairs.
Now that we have chosen to buy EURUSD as our directional trade we need to pick a currency pair in which to sell EUR against in order to create a hedge. In this case since we can see that JPY is showing the most comparative weakness so a good choice would be EURJPY. Our hedge trade is therefore to buy EURUSD and go short EURJPY. Risk should be kept the same for both trades so that the profit per pip is exactly equal for both pairs.
