At first glance, forex trading can be a hard and challenging skill to master. This is borne out by the numbers, which show that as many as 70% of forex traders lose money over time.
However, while succeeding as a forex trader can be hard, the 30% of investors who are profitable can achieve highly lucrative margins if they deploy the best and most agile trading strategies.
But what are the best hedging strategies for forex trading, and why are such entities so central to success in the marketplace? Let’s find out!
Why is Hedging So Important?
Hedging is best described as a form of insurance, as it refers to the process of safeguarding their capital against the impact of a negative event on their investments.
Rather than preventing such events from happening in the first place, however, hedging provides a safety net that minimises their impact, while helping you to retain as much of your capital as possible.
Hedging is most synonymous with the commodities market, where companies that are dependent on a particular product or resource look to safeguard themselves against price volatility by entering into a futures contract.
This is a type of hedging instrument that allows the business to buy the product at a specific price in the future, enabling them to budget effectively and minimise costs going forward.
But why is hedging so important in the forex market? Well, as we can see, the practice provides a layer of protection against volatility and significant price fluctuations, which are prevalent in the forex market and vulnerable to macroeconomic factors and real-time news events.
By its nature, forex trading also enables you to trade currencies in pairs and as derivative assets.
So, there’s scope to speculate on price movements and hedge against the decline of one currency against another, creating natural opportunities for hedging in the process.
What are the Best Hedging Strategies for Forex Traders?
In terms of practicality, modern-day forex traders are fortunate in that they can access a wide range of real-time hedging strategies through their chosen web trading platform.
The most popular strategy sees forex traders create a hedge to fully protect an existing position from an undesirable move in their chosen currency pair, primarily by holding both a short and a long position simultaneously.
This is commonly referred to as “the perfect hedge”, as it eliminates all the risk associated with a trade and creates more scope to pursue larger returns.
Traders can also create an “imperfect hedge” using forex options, although this is considered to be less effective as it only eliminates some of the investor’s risk.
However, this also places less downward pressure on potential profits, enabling you to retain more of your capital in instances where your initial position proves to be successful.
Clearly, your choice of strategy will have a direct impact on the risk-reward ratio associated with each position, so you’ll need to make an informed selection that suits your overall outlook as a trader.