What is hedging as it relates to forex trading?
When a currency trader enters into a trade with the intent of protecting an existing or anticipated position from an unwanted move in the foreign currency exchange rates, they can be said to have entered into a forex hedge. By utilizing a forex hedge properly, a trader that is long a foreign currency pair, can protect themselves from downside risk; while the trader that is short a foreign currency pair, can protect against upside risk.
The primary methods of hedging currency trades for the retail forex trader is through:
Spot contracts are essentially the regular type of trade that is made by a retail forex trader. Because spot contracts have a very short-term delivery date (two days), they are not the most effective currency hedging vehicle. Regular spot contracts are usually the reason that a hedge is needed, rather than used as the hedge itself.
A forex hedging strategy is developed in four parts, including an analysis of the forex trader's risk exposure, risk tolerance and preference of strategy. These components make up the forex hedge:
Analyze risk: The trader must identify what types of risk (s)he is taking in the current or proposed position. From there, the trader must identify what the implications could be of taking on this risk un-hedged, and determine whether the risk is high or low in the current forex currency market.
The forex currency trading market is a risky one, and hedging is just one way that a trader can help to minimize the amount of risk they take on. So much of being a trader is money and risk management, that having another tool like hedging in the arsenal is incredibly useful.

Forex hedging advantages

There’s two diverse opinions on the subject of multiple currency pair trading, do or don’t, yes or no. The principal use and major benefit for engaging in a multi pair trading strategy is to hedge the overall risk, this can be done by observing the currency pair correlations that exist in the market place at any given time. Many experienced traders suggest that hedging and or correlation trading should only be used on swing and or position trading strategies. If traders take the time to analyse the charts of the four main trading pairs and the three commodity pairs the correlations and the reaction to the main moves in the market can be clearly seen.
Certain brokers such as FXCC allow traders to place trades that are direct hedges. Direct hedging is when traders are permitted to place trades buying a currency pair and at the same time selling the same pair. Whilst theoretically at conception the net profit is zero when opening both trades immediately, traders can make more money without incurring additional risk if their market timing is right.
Hedging is by definition a method of devising a strategy in order to protect versus big losses. Hedging could be considered as an insurance policy versus individual or collective trades. If employed correctly hedging permits traders to reduce their losses particularly with regards to unexpected events taking place.
Simple Hedging Technique.
A simple forex hedge method is one that encourages trading in the opposite direction of the initial trade without having to close that initial trade. Whilst an argument could be put forward that it makes more sense to close the initial trade for a loss and place a new trade at a better price, this is at the heart the reason why a trader would use hedging as part of their trader discretion.
Traders could close the initial trade and enter the market at a better price. The advantage of using a hedge technique is that traders can keep their trade live in the market and bank additional profit with the second antagonistic trade which banks additional profit as the market moves against the first position. When suspecting that the market is going to reverse back to the initial trade’s direction, traders can set a stop on the hedging trade, or simply close it.
Multiple Currency Pairs Hedging Technique.
Experienced forex traders often take hedge trades versus a particular currency by using two different currency pairs. For example, you could go long on the EUR/USD pair and short the USD/CHF pair. In this instance and it’s not an ‘exact science’ technically traders would be hedging their USD exposure by pairing the USD versus the volatility of both the euro and Swiss franc.
The major contentious issue with hedging in this manner is that traders are exposed to both fluctuations in the Euro(EUR) and the Swiss(CHF). If the Euro suddenly develops market strength and becomes a strong currency versus all its peer currencies, there could be a fluctuation in EUR/USD that is not immediately counter acted in USD/CHF. This is generally not a reliable way to hedge unless you are building and operating a complicated hedge strategy that takes many currency pairs into account. This type of multi pair hedge/correlation strategy can take many years of experience to perfect, particularly if the trader trades the four majors and three commodity pairs concurrently.
A forex option is an agreement to conduct an exchange at a specified price some time in the future. As an example let’s suppose a trader places a long trade on the EUR/USD pair at 1.30. In order to protect that position the trader places a forex ‘strike option’ at 1.29. If the EUR/USD falls to 1.29 within the time specified for your option, the trader gets paid out and banks the profit on that option. How much the trader banks will depend on market conditions when you buy the option and the size of the option. If the EUR/USD does not reach that price in the specified time the trader loses only the purchase price of that option. The bigger the distance from the market price the option at the time of purchase is, the larger the profit will be if the price is hit during the specified time.
The main reasons to hedge is that traders want to use hedging to limit overall risk. Hedging can become a significant part of a trader’s trading plan. However, hedging should only be employed by experienced traders who understand market swings, positions and crucially market timing. Practising hedging techniques by even the most experience traders can be challenging, without adequate trading experience it could be prove to be a disaster.
Those new to hedging techniques would be best advised to monitor all four major pairs and the three commodity pairs on a swing strategy over a period of several months before engaging with the market. In doing so the trader will be able to clearly see the reaction between the main indice markets, the currency markets and the correlations between the seven pairs overall. Armed with this information and evidence the trader would then be ready to employ a hedge strategy with confidence.
One Response to Hedging Your Bets, The Advantages Of Multi Pair Currency Trading And Trading Against Your Own Trend.
Thank u FXCC for teachin us forex! I love FXCC! Daniel from Nigeria.

4 Reasons Currency Hedging is Important.
Almost every mutual fund and ETF has some degree of currency risk, as the companies in these portfolios may have operations in many countries. These businesses generate profits based on a foreign currency, which exposes the investor to currency risk. Consider these reasons why currency hedging is an important tool to reduce risk.
Assume, for example, that Acme Company is based in the United States and has retail stores in the United Kingdom. Acme provides capital to its U. K. stores, which requires the firm to convert U. S. dollars into pounds. Also assume that $1 is converted into £2.
Acme reports its year-end financial results in U. S. dollars. The profit generated by U. K. stores must be converted from pounds into dollars. Assume that the exchange rate is now $1 dollar to £4. It now takes twice as many pounds to convert into a single U. S. dollar, which makes the British pound sterling, or GBP, far less valuable.
This risk is also applicable to mutual funds and ETFs. If you own a portfolio of stocks based in the United Kingdom, you’re exposed to currency risk. The value of your fund can decline due to changes in the exchange rate between the United Kingdom and the United States, which is one of several reasons why currency hedging is important.
1. Eliminate Risk Over the Long Term.
Suppose you own a U. K.-denominated fund. Your investment objective is to own companies based in that country that perform well. The exchange rate between the dollar and the pound will change over time, based on economic and political factors. For this reason, you need to hedge your currency risk to benefit from owning your fund over the long term.
2. Foreign Stocks Add Portfolio Diversity.
You want to own companies in the United States and in foreign countries to properly diversify your portfolio. For example, frontier and emerging markets are attractive to investors who want to take more risk and achieve higher returns. Since most investors use foreign-based investments, they can reduce their risk exposure using currency-hedged ETFs and mutual funds.
3. Forward Contracts.
Many funds and ETFs hedge currency risk using forward contracts, and these contracts can be purchased for every major currency. A forward contract, or currency forward, allows the purchaser to lock in the price they pay for a currency. In other words, the exchange rate is locked in place for a specific period of time.
However, there is a cost to buy forward contracts. The contract protects the value of the portfolio if exchange rates make the currency less valuable. Using the U. K. example, a forward contract protects an investor when the value of the pound declines relative to the dollar. On the other hand, if the pound becomes more valuable, the forward contract isn’t needed.
Funds that use currency hedging believe that the cost of hedging will pay off over time. The fund's objective is to reduce currency risk and accept the additional cost of buying a forward contract.
4. Hedging Large Currency Declines.
A currency hedging strategy can protect the investor if the value of a currency falls sharply. Consider two mutual funds that are made up entirely of Brazilian-based companies. One fund does not hedge currency risk. The other fund contains the exact same portfolio of stocks, but purchases forward contracts on the Brazilian currency, the real.
If the value of the real stays the same or increases compared to the dollar, the portfolio that is not hedged will outperform, since that portfolio is not paying for the forward contracts. However, when the Brazilian currency declines in value, the hedged portfolio performs better, since that fund has hedged against currency risk.
Political and economic factors can cause large fluctuations in exchange rates. In some cases, currency rates can be very volatile. A hedged portfolio incurs more costs, but can protect your investment in the event of a sharp decline in a currency’s value.

What Are the Advantages and Disadvantages of Hedging in Finance?
Reducing risk can cause you to miss out on some opportunities.
Many companies use hedges to reduce their risk levels in key areas of their operations. These hedges can pay off for companies in situations in which changing market conditions would otherwise have hurt their profits, but they also come with a cost. Let's take a closer look at the advantages and disadvantages of hedging.
At the same time, commodity producers can open hedge positions that allow them to lock in fixed prices for their production in the future. If the price of that commodity goes down, then the hedge will protect the producer by rising in value to offset the commodity-price decline. Oil and gas exploration and production companies provide a useful example of this use of hedging, as some players in the oil-rich shale plays like the Bakken and Eagle Ford hedged their anticipated future production and therefore earned huge gains on their hedge positions because of the plunge in oil prices on the open market during late 2014 and 2015. Those companies that didn't hedge, on the other hand, face the full impact of the crude oil drop, and some are struggling to get the capital they need to keep operating.
The downside of hedging.
Moreover, some hedges are costly even if markets remain neutral. Like any insurance product, prices of hedges usually carry an upfront cost, and the hedging party typically has to count that cost against any profits from the position or add it to any losses.
Finally, some investors don't like it when companies have hedges. They want exposure to the risks of the industry and see hedging as an impediment to their own risk management as investors. Especially when hedging doesn't work out, investor pressure can lead to a company reversing course and removing hedges -- often at what proves to be the worst possible time.
Hedging is a tool companies can use to set their risk level. It can turn out well or poorly for a company, but it serves a useful purpose regardless of how things work out in the end. The stock market offers opportunities for investors of all types, regardless of how risk-tolerant you are; visit our broker center to start investing today.