If we don't understand the significant risk involved in hedging the risk we aim to avoid by entering a hedge may be less than the significant losses we may incur.You must therefore know the benefits and drawbacks of hedging.
Definition
Currency Hedging involves utilizing a strategy by purchasing a foreign exchange option or by directly opening a position in order to protect you against unprofitable movements in the forex market.Accordingly an investor which we assume has made the correct decision to undertake a long hedge position has protected him from downside risk and an investor which has undertaken the correct decision to undertake a short hedge position will protect himself from upside risk.There are two methods of undertaking a hedge: 1. SpotContracts: These are the usual contracts we encounter on a daily basis.They are not frequently used because of their short term nature. 2. Option contracts: These give you the right(not a must) to trade a given currency pair in the agreed way in the future. These are the preferred hedging vehicles due to their long term characteristic.
Advantages of Hedging -It minimizes probability and magnitude of losses in the short term when used by longer term traders. -It can be used for capturing profit. -It can aid during difficult market periods. -when utilized correctly it can shield you from commodity price changes, interest rate changes, etc -It can also save time as the long-term trader is not required to monitor/adjust his portfolio with daily market volatility. -Hedging using options provide the trader an opportunity to practice complex options trading strategies to maximize his return.
Disadvantages of Hedging -It involves cost that can eat up the profit. Therefore care must be taken to ensure the decision is the correct one. -Decreasing risk usually goes along with a decrease in profits. -It is not practical for the short term trader.Why? Because of increased noise in the market when using shorter timeframes. If the market is trending then it has little function. Trading of options or futures often demand higher account requirements like more capital or balance. It may be very complex for beginners so it is therefore advisable only for experienced traders with good trading skills.
As with all trading methods, risks are involved. And this risks can lead to huge losses. Before you embark on any type of strategy, you need to understand its underlying concepts clearly.
Definition
Currency Hedging involves utilizing a strategy by purchasing a foreign exchange option or by directly opening a position in order to protect you against unprofitable movements in the forex market.Accordingly an investor which we assume has made the correct decision to undertake a long hedge position has protected him from downside risk and an investor which has undertaken the correct decision to undertake a short hedge position will protect himself from upside risk.There are two methods of undertaking a hedge: 1. SpotContracts: These are the usual contracts we encounter on a daily basis.They are not frequently used because of their short term nature. 2. Option contracts: These give you the right(not a must) to trade a given currency pair in the agreed way in the future. These are the preferred hedging vehicles due to their long term characteristic.
Advantages of Hedging -It minimizes probability and magnitude of losses in the short term when used by longer term traders. -It can be used for capturing profit. -It can aid during difficult market periods. -when utilized correctly it can shield you from commodity price changes, interest rate changes, etc -It can also save time as the long-term trader is not required to monitor/adjust his portfolio with daily market volatility. -Hedging using options provide the trader an opportunity to practice complex options trading strategies to maximize his return.
Disadvantages of Hedging -It involves cost that can eat up the profit. Therefore care must be taken to ensure the decision is the correct one. -Decreasing risk usually goes along with a decrease in profits. -It is not practical for the short term trader.Why? Because of increased noise in the market when using shorter timeframes. If the market is trending then it has little function. Trading of options or futures often demand higher account requirements like more capital or balance. It may be very complex for beginners so it is therefore advisable only for experienced traders with good trading skills.
As with all trading methods, risks are involved. And this risks can lead to huge losses. Before you embark on any type of strategy, you need to understand its underlying concepts clearly.
About the Author:
A risk management strategy is used in restricting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or investments. Have a look at Dukascopy forex broker wherein hedging is permitted which can offer traders with more choices on creating their trading strategies. Also, check out another great review on Loyal Forex Broker.
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