Traders in every market small or big aim for decreasing risk and increasing the profit margin. This phenomenon becomes all the more important in the Forex trading business. Traders use some sure shot strategies to accomplish this feast, Hedging being one of them. In fact, hedging is one of the highest used strategies. Most large companies have a mandatory norm to use hedging as a component of their tactics. The hedging technique is so famous that it even has investment funds named after it. Since they ‘hedge’ most traders thus come the ‘hedge funds’.
Insurance allows the traders or businessmen to cover their risk upto a certain limit, but the downside is they also demand fixed sums of timely payments. The hedging technique was built to skip over the insurance fees in the financial markets. For a company to ‘hedge’, it needs to buy and sell and the same time or within a short period. They can use two different instruments either in different markets or in just one, such as Forex where different currencies are traded.
In order to ‘hedge’, a Forex Broker is required to choose two positively correlated pairs for e.g. USD/EUR and USD/GBP and take opposite directions on both. The prime motive of using hedging is to eliminate the risk loss during times of uncertain market conditions.
While safety is important it is not the only concern while trading. Because of this reason technical and fundamental analysis is done to make hedge technique profitable and not just safe. For what is a business without profits?
The analytic ability comes into play when during deciding a hedge the trader employs analysis to spot two correlating pairs that won’t act exactly the same to the downside or upside movement.
Hedging is not only a strategy that helps in predicting which way a certain pair of currency may go but rather it is a method that helps traders use the market to their best advantage without even realising. Hedging provides a parallel form of ‘insurance policy’ for trading currencies in the Forex market. If hedging is understood properly and applied by the correct methodology, losing trade can be minimized to almost zero. It must also be noted that like all other strategies hedging also is not fool proof and cannot provide exceptional results alone. It needs to be used in conjunction with other strategies in order to understand various possibilities.