Forex and Hedge Trading
March 26, 2009 by admin
Filed under Forex Systems
Forex and Hedge Trading
Many Forex trading systems allow users to open a special trading position called a "hedge". Normally when investors make trades in Forex, they buy or sell a currency pair. You can go long, hoping that the base currency will increase, or go short, hoping that the base currency will fall. For example, if you are trading EUR/USD, the base currency is the one on the left, or the European Euro. If you are going long on EUR/USD, then you are hoping and anticipating that the Euro will rise relative to the US Dollar. If you are going short, then you are hoping that the Euro will fall relative to the US Dollar.
In hedge trading, you open two positions instead of one. The two positions cancel each other out. For example, if you hedge EUR/USD then it means that you are opening one position long and an equally sized position short. So if the EUR/USD then raises 5 pips, your first position would have raised 5 pips and your second position would have lost 5 pips. So what’s the purpose of that, aren’t you just canceling out any gains and losses? Actually, yes you are canceling them out and if you factor in the spread or commission then you are actually going to lose money.
So why would anybody use a hedge trade? Well, if you are losing money on a trade and want to immediately protect yourself from losing more money, you can open a hedge so that even if you trade continues to lose money, you will have an equal and opposite trade that will cancel out any more money lost.
Additionally, some traders use advanced systems with hedging. For example, one investor opened a hedge position with GBP/CHF (British Pounds to Swiss Francs). He put stop orders for both hedges so that if it rose or fell to certain levels he would then sell one of the positions. He then back-tested his formula over several years and found that the system would bring in 13% profits on average per month. So hedges aren’t only used by novice traders to protect themselves from further losses, but also by more experienced traders who have devised trading strategies that can use them as part of a strategy that works fairly consistently.
For the beginning trader, hedges probably won’t be a big part of trading, but beginning traders should know what hedging is because they will read about it and see options for hedging in their trading platform. Big banks and experienced and skillful traders can find ways for hedging in an overall strategy for trading with profitable results.
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