In today’s online trading, retail investors’ accounts lose money rapidly due to leverage, huge market turmoil, overall bad money management, or bad choice of a broker. Going for Forex brokers that allow hedging is an effective way to counter the risk of losing money.
So, we’re going to go over everything from what hedging is in Forex to the Forex brokers that allow hedging to the key tools you can use.
We will also tell you the criteria for choosing a good broker that allows you to hedge currencies in a profitable and safe environment.
What is Forex Hedging?
In a nutshell, “hedging” is something Forex traders do to offset the threat of price swings later on. By doing this, you are shielding your position.
The mentioned protection is a short-term solution. Traders usually implement it due to volatility in the Forex market or some big news that will likely affect the Forex market.
Here are some of the most prominent currency hedging strategies brokers use today.
Direct Hedging in Forex
Sometimes referred to as “single hedging,” this is usually when a trader opens two positions in opposite directions. It will be a long (buy order) and a short (sell order) – so they’re going in opposite directions.
Here’s an example of what the cover looks like:
Let’s say you already had a short position in a currency pair like AUD/USD. But there is news of an event that you think will affect the US dollar.
You want to open a long position on the same pair, and you just hedged your Forex trading.
Your net profit in direct hedging will be zero. So, you keep your original position in the Forex market. And there you go; you are ready for when the trend reverses.
If you protect yourself, you can profit with the second trade when the market goes against your original trade. If you have decided not to hedge this position, you may have closed your trade and suffered a loss.
Beware that not all Forex brokers allow direct hedges, so they would instead choose to offset positions.
Multiple Currency Hedging in Forex
Another currency hedging trading strategy is to choose two different currency pairs that are considered “positively correlated” and take opposing positions on each pair.
The “correlation” of the pair statistically illustrates how currencies have performed over a specific period, mainly whether they moved in opposite directions, in the same direction, or at random.
Correlation coefficients are used as a measurement technique in this case to determine the strength of the relationship between two fluctuating currencies. It’s displayed as a decimal from -1 to +1.
You should not take hedging multiple currency pairs lightly, as there are risks involved.
The main contrast between those mentioned above, “direct hedging” and “multiple currency hedging,” is that a single position could potentially bring more profit than other losses when hedging with multiple currencies. With direct hedging, the bottom line would rarely exceed zero.
Tools for Forex Hedging
When it comes to tools preventing investor accounts from losing money, there are a few terms that you will regularly see when hedging Forex. As such, we have put together an explanation of some commonly used hedging tools.
These are the tools Forex brokers that allow hedging offers to their clients:
Automated Forex Hedging Robot
Using an automated trading system when hedging Forex can be extremely helpful. It’s particularly the case if you are a new trader or just want to take a step back. You’ve heard of Forex trading robots, also known as Forex EAs (Expert Advisors). They’ve gotten a lot of coverage on social media lately, not least because of celebrity endorsement claims.
If you are not aware of the phenomenon, an automated trading robot will buy and sell on your behalf using sophisticated algorithms. Therefore, the trading bot allows you to trade 24/7 days passively. Forex hedging robots can be preset in such a way as to make them perfect for risk management.
In other words, it will combine investigating trends, buying, selling, and opening multiple positions at once. Just like when protecting yourself, the Forex robot aims to maintain your flow of funds and enables you a safety net for when or if something unexpected happens in the Forex market.
Unless you have placed a stop order in this type of trade, your Forex broker will automatically close the first position. Essentially, the new trade will cancel it out – this is known as “clearing.”
Here is an example of ‘net off’:
Let’s suppose that you have a buy order in EUR/USD for EUR 200. Then you execute a sell order of 200 EUR on EUR/USD (to hedge it)
The original position will be closed if you place the opposite order. Your order has been “cleared.”
Consequently, if you are trading Forex, commodities, stocks, bonds, or any other asset class, you will always close a position by placing an opposite order to the current one. As such, you will need to find a Forex broker that allows hedging and having both a buying and selling position open simultaneously on the same currency pair.
Forex Hedging using Open Force Function
Force Open is a useful hedge trading feature that prevents brokers from offsetting your positions. Simply put, this feature means you can open a new position – in the opposite direction of the original trade.
As a result, you can keep both positions open in the same market space – and on the same asset (long and short).
Below is an example of an “open force.”
In this case, let’s say you open a short position of GBP500 in AUD/NZD.
You predict AUD/NZD will experience a brief rise in price
Let’s say you now open a buy position of GBP 500 AUD/NZD (to reduce potential losses).
In this scenario, brokers will usually offset both of your positions. So, as we explained above, that means your first position will be closed. However, by choosing to “force open,” both of your orders will still take place.
How to Find Forex Brokers that Allow Hedging
Some brokers don’t allow hedging, so finding Forex brokers that allow hedging can be a challenge.
Pay attention to following when looking for Forex brokers that allow hedging.
License and Regulation
Making sure that a broker is licensed is essential to protect traders against financial crime or the bankruptcy of a broker. Not to mention the protection of customer transparency and creating a more equitable economic space for all.
Every broker you come across differs when it comes to fees. While one broker may charge a commission for each trade, another trading platform will be commission-free – but will charge high night and inactivity fees.
If the broker has high commission fees attached to every Forex transaction, you may want to reconsider them for your hedging efforts.
Let’s say you trade AUD/USD, and your broker wants a commission of 0.8% per trade. Now let’s say you bet GBP 1,500. Your broker will take GBP 12 when the position is open.
Assuming your hedging position is closed at a break-even point, you will have to pay a commission of GBP 12 again.
In our example, a commission devouring that much on each trade would make the hedge unsustainable for you. Of course, the idea with hedging isn’t necessarily to make huge gains. It’s to reduce your risk of losing money rapidly due to bad money management and by balancing that out.
Fortunately, there are a handful of highly professional and regulated brokers in the space, which will allow you to trade commission-free!
Tight spreads are welcome and always great for traders, but this is especially the case for Forex hedging.
Here is an illustration of what the spread might look like with a 4 pip spread:
Say you are trading GBP/USD. The purchase price is 1.1443. And the “sell” price is 1.1447. 4 pips may not seem like a lot, but it is considered expensive in the Forex brokerage space. As such, it would make the Forex hedging strategy impractical.
For this reason, most of the good brokers offer a spread of less than 1 pip on the major currency pairs – which is really competitive. Platforms like eToro also offer variable spreads. Simply put, this means that the spreads change based on market conditions.
Diversity of Currency Pairs
When it comes to Forex, there are tons of currency pairs to choose from. Ideally, your broker will have a good selection for you – from miners and major pairs to exotic and emerging currencies.
Deposit and Withdrawal
Again, each platform will be different. Customers can make deposits using a wide range of payment methods such as credit/debit cards, wire transfers, and electronic wallets like PayPal. Some companies even allow merchants to pay via certain cryptocurrencies such as Bitcoin. Although this is granted, it is not as common as Visa.
When it comes to processing times, the vast majority of brokers will process your deposit immediately. However, regarding payment methods, it is important to note that if you are depositing by wire transfer, it may take days to access your trading account.
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