With hedging, you will get away to protect your trades from a huge loss. It is basically similar to when you buy car insurance to protect yourself from an expensive accident. It is a way to cover or decrease the loss you will face if there is an unexpected thing happens.
The definition of Forex Hedging
Several forex brokers allow traders to make trades with a direct hedge. With a direct hedge, traders can place a trade to buy one single currency pair, while also placing a trade that sells the same pair, at the same time.
The net profit for those two trades is zero when you open both of them. But, you can gain more money without having additional loss if you predict the market just right.
The Protection Provided by a Hedge
Forex hedging gives you protection since it allows you trading the opposite direction of your initial trade, without closing it. But, some traders may think that to close the initial trade at a loss, then make a new trade make more sense. The decision is in your hands.
It is possible to close the initial trade and re-enter the market later at a better price. The main advantage of hedging is you can keep your first trade while gaining profit from the second trade as the market against your first trade.
Ways to Undo a Hedge
Once you think that the market goes reverse and favor your initial trade, you can put a stop loss in your hedging trade or just simply close it. You can find various ways to do forex hedging.
Multiple Currency Pairs
A trader is allowed to hedge against one single currency with two different currency pairs. For instance, you can purchase a long position in EUR/USD and a short position in USD/CHF.
In this scenario, you will be hedging the USD exposure. Yet, you are also exposed to the fluctuations of the Euro (EUR) and the Swiss (CHF).
In another word, if the EUR becomes a stronger currency against all other currencies, that triggers fluctuation in EUR/USD but not counteract your USD/CHF trade. Thus, the example above is not a reliable way to do forex hedging unless you have built a complicated hedge involving many currency pairs.