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Hedging Forex: Should You Hedge Forex?

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Hedging is a trading strategy used to mitigate losses by taking market positions that offset the risk exposure of the initial position or investment. The trade or investment taken to offset this initial risk is called a hedge.

It’s important to learn about hedging because when done right, hedging can protect your trades, investment, and capital. Before using this strategy, you need to understand what it means, how it works, and the different ways of using it.

In this review, we will discuss what hedging means, how it’s done, as well as the best brokers to hedge forex with. Let’s begin!

Hedging Forex: What is Hedging Forex

Hedging is a trading strategy that can be applied to various assets in the financial market. In relation to forex, hedging involves taking forex trades that offset or mitigate the losses or potential losses of an original position or investment. A hedge trade can be executed with;

Forex Hedging is used by a lot of players in the Forex market Including traders, investors, and businesses because it acts as a safety mechanism that can help them minimize, mitigate and control their losses.

Spot positions can also be used to hedge forex trades effectively. If the forex risk is longer than the spot delivery date you can make use of assets like futures, and forex options contracts as hedges.

How does Forex Hedging Work?

Forex hedging involves offsetting the losses of currency trading using the same currency pair as the original trade, or an asset of an entirely different class. Hedging forex can be done with; currency options, spot contracts, and currency futures.

Foreign Currency options are the most popular amongst traders when hedging. Foreign Currency options allow a trader to buy or sell the currency pair at the same time. The initial trade can be executed on a forex trading broker and hedged with an opposite trade on the same broker, or an opposite trade on a forex options broker.

On the other hand, Spot Contracts are the least popular hedging option amongst Forex traders because they only have a delivery date of about 2 days which is short and often insufficient.

There are two main hedging strategies in the Forex market, and these strategies have their Pros and Cons. We will discuss both strategies to help you decide which hedging strategy to choose while trading.

Forex Hedging: Forward Position or Hedging a Spot

The first hedging strategy is known as “Forward Position” or “Hedging a Spot“. In this hedging strategy, a Forex trader creates a hedge position with a risk exposure that is equal to that of the original trade. This forex hedging strategy is used to secure the trading capital by using hedge trades that completely mitigate the losses that can be incurred on the initial position.

The Forward Position hedging strategy is a direct hedge, and a lot of traders refer to it as a “perfect hedge” or “direct hedge”. This is because the Forward position prevents you from losing money rapidly, and eliminates the risks of incurring significant losses since the net exposure is zero.

Unfortunately, US brokers do not allow “Forward Position” forex hedging strategies.

Forex Hedging: Hedging a Contingent Exposure With an Options Contract

Photo: Research Gate

In this hedging strategy, the investor buys a put options contract if the investor is currently holding the long position in a currency pair. The Put Options contracts are used to minimize the foreign currency risk by indirectly providing a hedge trade.

This forex hedging strategy is also referred to as an ”imperfect hedge” because it does not completely eliminate the risks exposure on a currency pair.

An imperfect hedge in the foreign exchange market is created when a trader who is currently holding the long multiple positions puts option contracts to reduce the risk appetite, and the trader who occupies the short position decides to move up by calling option contracts to reduce the significant risk.

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Best Brokers for Hedging Forex?

Forex traders can practice currency hedging on their retail investor accounts through forex brokers. Brokers have different rules and trading conditions, therefore it’s important to carry out adequate research before choosing a broker to hedge forex with. Fortunately, we have done extensive research for you, and here are the best brokers for hedging forex.

BrokerBest ForMore Details

Advanced Non US Traders
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securely through Avatrade website

Overall Broker
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securely through Forex.com website

Lowest Spreads
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securely through IG Broker website

#1. Best Overall Brokers: Avatrade

AvaTrade is an Ireland-based online broker regulated by the European Union, and it allows all of its users to take advantage of the Forex hedge strategy. AvaTrade is considered to be one of the most secure online traders since it is not traded publicly, and it does not operate a bank.

AvaTrade permits all forex hedging strategies. The fast trade execution, low spreads and impeccable reputation of AvaTrade make it the best broker for hedging forex and currency risk.

How does it work?

To use AvaTrade online brokerage service for trading in the Forex market, you will first have to create an account with the AvaTrade platform. Once your account is set up, you will have to verify your identity and make a minimum deposit of $100.

Now the range of markets you can trade on AvaTrade depends majorly on the trading platform you have chosen. AvaTrade offers currency pairs CFDs trading, Crypto CFDs investments, over 55 Forex pairs.

To hedge currency on AvaTrade, you need to select a currency pair to trade and decide the hedging strategy to use. AvaTrade permits both direct hedges and imperfect hedges.

Pros

Cons

Commission & Fees

The above image is a perfect representation of the commission and fees charged by AvaTrade.

BrokerBest ForMore Details


Best Overall Broker
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securely through Avatrade website

#2. Forex.com

Forex.com is widely used by experienced traders, new Forex traders, and CFDs traders as it offers a wide range of trading markets, and it also offers a large number of proprietary platforms. Forex.com is regulated by the NFA of the United States of America. This is why you cannot use Forex.com broker to place a hedge on your existing positions in the same trading account if you are located in the US.

How does it work?

Forex.com offers its services all over the world, and your location would play a major role in deciding the services that you can use on the platform. This is because there are different regulatory authorities in different parts of the globe, and the Forex.com online broker needs to take all of them into account. For example, traders based in the United States of America cannot use Forex.com to trade in CFDs.

Fortunately, US traders can still hedge trades on Forex.com by opening two different accounts on the platform. This allows them to take opposing trades on them and mitigate losses.

Forex.com not only offers its own flagship trading platforms for both desktop & web trading platforms, but it also offers full access to both MetaTrader 4 & MetaTrader 5 suites.

Pros

Cons

Commission & Fees

BrokerBest ForMore Details


Overall Broker
Read Review


securely through Forex.com website

#3. IG Markets

IG markets are one of the most used Forex trading platforms all over the world, and at present, it has over 200k active users who have joined and stayed with the platform owing to its product catalog, attractive commission, low charges, and great reputation.

How does it work?

IG Markets offers multiple CFDs and financial instruments to its users located outside of the US. To make trading easier, IG Market has developed their own mobile application which is considered to be the best in the business by a lot of experts. It is packed with useful features that are of benefit to novice and experienced traders.

The broker supports a variety of foreign exchange hedging strategies and makes hedging effective through their low spreads and commissions as well as speedy trade execution. Hedge trades can be taken on a single currency pair on the platform or by trading a currency pair with another closely correlated asset offered by IG markets.

Pros

Cons

Commission & Fees:

BrokerBest ForMore Details


Lowest Spreads
Read Review


securely through IG website

Risks with Hedging Forex

Foreign exchange hedging helps to reduce the risk of trading a financial asset or forex pair. It ensures that losses can be mitigated and protects traders that have a high risk of losing trades.

Though hedging is aimed at mitigating losses, it can lead to more losses if it’s not done right. To hedge successfully, traders need to understand Intermarket correlations and trade management. If a hedge trade is executed in the wrong direction, it would increase potential losses instead of mitigating them.

Sometimes, hedging leads to a loss of profits if the original position turns out to be profitable. The hedge trade in this instance turns out to be a loss, thereby canceling out the originally profitable trade.

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Photo: asiaforexmentor.com

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Conclusion: Should you Hedge Forex?

Hedging strategy is a great risk and money management strategy that can be employed by both experienced and novice traders.

It helps traders make the right trading and Investment decisions, mitigate losses and protect their trading capital. Before hedging, ensure that your chosen broker is regulated and permits hedge trades.

To take successful hedge trades, you need to carry out adequate research and market analysis to support your trading decisions.

Forex Signals FAQs

What is Hedging?

Hedging is a trading strategy used to offset losses by taking trades that mitigate the losses or potential losses of an existing trade.

Is Hedging Profitable?

Hedging can lead to profitable trades when done right. However, the main purpose of hedging is usually to protect the trading capital and control losses.

Do All Brokers Allow Hedging?

Not all brokers allow hedging. Hedging can be influenced by the broker’s rules or the rules set by your local, national or regional regulatory agencies.

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