Forex Hedging Strategy - Protection against losses

By: Harold Hsu
Many Forex retail traders think that hedging is a good way to minimize losses. When holding on to a losing position, they often take up some form of hedging strategy to protect themselves against further capital depletion.

In this article I will discuss what a hedging strategy is, and why it’s a bad idea for retail traders to consider any type of hedging strategy at all… hedging is not for retail traders!

What Is Hedging?

Basically, hedging involves the buying (or selling) of currency pair(s) in order to protect the hedger against unwanted currency fluctuations. Traditionally, hedging was used to protect the profits of multinational companies from unfavourable currency fluctuations.

Hedging is a great way for these companies to protect their profits, but unfortunately many inexperienced Forex traders have incorrectly applied the same principles to their trading activities.

Here’s how a Forex trader may try to hedge his position:

Imagine that I buy the EUR/USD currency pair, and the market immediately moves against my position (i.e.

prices went down). At this moment, I would be facing an unrealized loss. In order to ‘protect’ myself against further losses, I might sell the EUR/JPY currency pair in the hopes that any gain in the latter pair will partially offset the losses of the former pair.

Essentially, I’ll be holding on to two simultaneous ‘long’ and ‘short’ positions for the Euro currency. Hedgers hope that the results of both positions will partially cancel each other out.

Why Hedging is A Bad Idea for Retail Traders

This method of hedging is a deathtrap waiting to spring. The original purpose of a hedge was to reduce the uncertainty of company profits.

To the retail trader, however, this does the exact opposite!

Such a hedging strategy simply leaves too many factors open to risk. Although the Euro price fluctuations may be somewhat muted, the ‘retail hedger’ now has worry about the USD and JPY currencies too! The EUR/USD and EUR/JPY pairs are not highly correlated and may end up causing an even larger total loss in the end.

Many people like to hedge because they don’t want to admit that they made a bad trading decision. They try to ‘safely’ hold on to a losing position for as long as possible in this manner, but don’t realize that they’re actually exposing themselves to even greater risks!

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