Forex hedging is a popular risk management strategy used by investors to protect their capital from undesirable fluctuations in the currency market。

What is hedging？

Hedging is a risk management strategy applied to all financial instruments to offset risk by taking different positions。This allows investors to offset the risks associated with a single currency by opening additional positions。In addition, they aim to protect themselves from adverse market volatility。

How Forex Hedges Work

Investors who use hedging in the foreign exchange market strategically open multiple positions to protect their capital from unnecessary market volatility。Therefore, they mitigate the risks associated with the money market by ensuring that their exposure is fully balanced。

How to Hedge Forex

As mentioned earlier, the main purpose of foreign exchange hedging is to reduce the overall risk of the portfolio。Given the natural volatility of currency markets, investors are using a variety of tools to offset risk。

Let's use a simple example to show how forex hedging works in practice。Once the price breaks through the key short-term resistance level, you decide to 1.Buy EUR / USD at $10 market price。

The overall trend is clearly skewed to the upside, so you want to follow this trend for as long as possible。The price action then hit the key medium-term resistance level 1..1420美元。At this point, you realize that the market is likely to move in the opposite direction。

Since you still think that the overall trend is bullish and there is more room for EUR / USD to rise, you decide not to book profits。Instead, you eventually decide to open a second trade to hedge against short-term losses on your first trade。

The second is short-term trading of a volatile nature.。If the pair continues higher and breaks through the resistance level, your first trade will extend the gains and the new trade will result in losses。However, if from 1.$1420 pullback, the gain on the second trade will help you offset the loss on the first trade。

Forex Hedging Strategies

The example we described above is one of the basic forex hedging strategies。Protected the original position from a pullback by opening the opposite trade of EUR / USD。That's why this way of reducing risk is called direct hedging。

In fact, there are many different trading strategies designed around forex hedging。Here, we will describe two popular forex hedging strategies。

Direct hedging

Direct hedging can take different forms。

Action should be based on the belief that the downturn is temporary and that the general trend remains skewed to the upside.。So you decide the second deal is buying you time。If you're not hedging your original position, closing out means you're taking a loss。

That way, you want the trend reversal to happen soon。If the downturn is indeed temporary, you will make money on the second trade before it turns green。

Some brokers (mainly in the US) do not allow direct hedging。So it may be necessary to do some research and find a broker that allows direct forex hedging。

Hedging with multiple currencies

Another form involves holding opposite positions in related pairings。

For example, initially you are long EUR / USD and then decide to hedge your GBP / USD risk by buying USD against other currencies (e.g. EUR)。So you will go long EUR / USD and short GBP / USD。

There will be losses if the former falls, however, these losses may be mitigated by the gains of the latter and vice versa。Keep in mind that forex hedging is more focused on reducing risk than making a profit on risky trades。

While direct hedging is very simple, it is recommended that more advanced forex traders hedge more than one currency pair。In this case, in addition to reducing dollar risk, there is also exposure to euro and sterling risk。

In the end, one of the situations may be that you lose money or make a profit on both trades。Or, in most cases, you want one position to generate more profits than another position to generate losses。

Conclusion

Forex hedging is about reducing risk, and investors use this trading strategy to protect their capital from adverse fluctuations in the money market。While there are different forms of foreign exchange hedging, direct hedging is arguably the simplest and hottest form of risk reduction by taking multiple positions。