subject: Hedging Forex And How It Works [print this page] A strategy used by many veteran forex traders to reduce the risk of the market is commonly referred to as hedging forex. Typically, a new trader to the market won't even have an awareness of this technique but experts use it regularly. Hedging essentially involves buying and selling pairs of currency as a form of added protection against market fluctuation.
You can think of this concept in the same way you would purchasing car insurance. With insurance you purchase a policy to lower the cost of recovering from an accident. Although you can not purchase complete coverage of course. The same for hedging, you covered to a certain extent but there is no way to get complete protection. It essentially protects the position of the currency pair from down or upside risks.
Forex traders use a wide variety of different strategies to help them, but the most common one is using derivatives. In the forex market this is referred to as a futures contract. It is like a normal contract except that currency is being traded instead of a stock. With this there will be some type of agreement to either buy or sell the currency at a specified price on a set date.
The use of multiple currency pairs is also popular. With this a trader will hold two different pairs. If one pair is seeing too much fluctuation the trader can then use the other one to offset the loss. Both short and long term position happen at the same time.
Some traders even go as far as using interest rates as a hedging tool. In this technique you would take on multiples of the same currency through two brokers. One broker charges interest and the other does not. When the market sees an uptrend you can then benefit from both brokers but when the market isn't so good you will only pay interest to one of those brokers.
Hedging can be very complicated and complex so you shouldn't attempt it if you are newer to the forex market. Those who have been trading for a while will do much better with these types of strategies.
