What is Forex Hedging?
Forex hedging is a strategy which is used by the forex traders in order to reduce the risk which is usually associated in the forex market. Most beginners who trade in forex market are not even aware of forex hedging techniques.
But these strategies are used regularly by the expert traders to minimize the losses. In high level terms, the forex hedging involves selling and buying of currency pairs so that they can be protected from the fluctuating exchange rates.
The term 'forex hedging' can be thought of buying a car insurance policy. In case of car insurance, the policy reduces the cost to be borne by you in case of negative events; still you cannot be completely covered.
Similarly, when you make use of forex hedging strategies, you are covered to some extent but complete protection is not available. Forex hedging protects the long or short position of a currency pair against downside or upside risk.
What is Forex Hedging?
There are various strategies which are used by forex traders. The most popular among them is the usage of derivatives. The term which is used in forex market is called a futures contract. This contract is very similar to a normal contract, the only difference being that a currency is being traded instead of a stock.
In this contract, there is an agreement to buy or sell the currency at a particular price on a specified date. The work similar to normal contracts and these provide a very good strategy to hedge against currency rate fluctuations.
One more popular forex method is to use multiple currency pairs. For example, in this strategy a trader can hold two different currency pairs like euros-to-dollars and euros-to-yen.
In can euros-to-dollars is facing difficult times, the trader can easily offset the losses by selling the euros-to-yen currency pair. In this case the short and long positions of euro occur at the same time therefore becomes a good hedging strategy.
Some forex traders also use the difference of interest rates as a hedging tool. In this hedging strategy, the traders take positions of the same currency pair with two different brokers. One of these brokers charges some interest while the other one does not.
When the market is positive, the trader gains from both traders. But when the market is not favorable for that currency pair, then he will have to pay interest to only one broker while he earns the rollover interest from other broker. Forex hedging should be done by experienced traders only since it can be very confusing for a beginner to forex market.
The author writes articles on finance including stock market like how to get rich with stocks and also forex articles including forex hedging and forex signal services.