If you ever wonder what forex hedging is, it is the process of opening multiple new positions to minimize currency risk in forex trading. Due to factors that are unfavorable to forex trading such as changing interest rates or inflation, the foreign currency markets can be heavily affected. Therefore, traders seek to safeguard their open positions by buying or selling more assets to lower the overall exposure risks. Forex hedging is usually a kind of short-term protection, especially when a trader is worried about news or an event that can cause volatility in currency markets.
Hedging currency risk normally involves a high level of expertise from people who understand the hazards of dealing in such a volatile market. Beginner traders, on the other hand, may learn the process of forex hedging if they are determined and have a good understanding of how the market operates.
Looking at the hedging strategies, forex correlation hedging may be one of the most well known strategies in the forex market. It includes the usage of currency pairs that are highly positively or negatively correlated. A good example would be the GBP/USD and GBP/JPY exchange rates, where under certain circumstances, the percentage of positive correlation between those pairs can go up to 90%. You can interpret that by saying, for 90% of the time, the two pairings are moving in the same direction.
As we know, pairs trading can be used by forex hedgers in both the short and long term. The forex correlation hedging strategy is also market neutral, so fluctuations have no influence on overall positions but rather, it balances positions that act as a hedge against one another. This particular strategy is highly effective in a volatile forex market. Due to the large number of financial instruments that have a positive correlation, pairs trading can also help you broaden your trading portfolio.
As for forex traders who do not want to open many positions for hedging, option trading may be an alternative. This hedging strategy involves the purchase or selling of currency at a fixed price at or before a future expiration date. Since forex options can expire at any time, they are primarily used as a short-term hedging strategy. Options are priced using market prices for currency pairs, specifically the base currency.
For example, a trader decides to buy a quantity of GBP/AUD as a “call option” because he believes the price will fall. He then buys a “put option” and sells an equal quantity of foreign currency short at the same time to profit from the price drop. As a result, the trader is hedging any currency risk from the dropping position in this way, and he is more likely to avoid losses.
If you’re a forex trader looking to learn how to manage risk, forex hedging is definitely one of the methods you should consider. The first step that you can take is to create a demo account with best online forex brokers indonesia and practice forex hedging strategies without real risk.
Next, select a currency pair to work with to learn how to profit from market volatility. Thirdly, make a detailed plan on your currency hedging strategy with a clear goal or objective in mind. Lastly, always remember to keep up with the latest news and trends.