If we don't comprehend the obvious risk there is in hedging the risk we were hoping to avoid using a hedge will be significantly less than the actual 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.Because spot contracts are usually short term they are not the preferred method. 2. Option contracts: These give you the right but not the obligation to trade as undersigned on a particular currency pair 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 enables traders to survive hard market periods. -Successful hedging gives the trader protection against commodity price changes, inflation, currency exchange rate changes, interest rate changes, etc. -It is not time-consuming for the long term trader since it doesn't require daily monitoring. -It can give you the opportunity to practice complex option strategies to get the best returns.
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. -Risk and reward are often proportional to one other; thus reducing risk means reducing profits. -For most short-term traders, e.g.: for a day trader, it is a difficult strategy to follow. Why? Because the currency market is more volatile and more unpredictable when analyzed from shorter time frames. If the market is trending then it has little function. Using hedging may require you use an account of higher category e.g. with a higher account balance. It is a precise trading strategy and successful hedging requires good trading skills and experience so it is very unadvisable for inexperienced traders and beginners as some strategies (the successful ones) can be very complex to understand and implement.
As with all trading methods, risks are involved. As with any type of investment approach, hedging also has risks that can result in 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.Because spot contracts are usually short term they are not the preferred method. 2. Option contracts: These give you the right but not the obligation to trade as undersigned on a particular currency pair 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 enables traders to survive hard market periods. -Successful hedging gives the trader protection against commodity price changes, inflation, currency exchange rate changes, interest rate changes, etc. -It is not time-consuming for the long term trader since it doesn't require daily monitoring. -It can give you the opportunity to practice complex option strategies to get the best returns.
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. -Risk and reward are often proportional to one other; thus reducing risk means reducing profits. -For most short-term traders, e.g.: for a day trader, it is a difficult strategy to follow. Why? Because the currency market is more volatile and more unpredictable when analyzed from shorter time frames. If the market is trending then it has little function. Using hedging may require you use an account of higher category e.g. with a higher account balance. It is a precise trading strategy and successful hedging requires good trading skills and experience so it is very unadvisable for inexperienced traders and beginners as some strategies (the successful ones) can be very complex to understand and implement.
As with all trading methods, risks are involved. As with any type of investment approach, hedging also has risks that can result in 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 utilized in restricting or offsetting odds of loss from fluctuations in the prices of commodities, foreign currencies, or securities. Have a look at Dukascopy forex broker in which hedging is allowed and this can provide traders with more options on creating their trading strategies. Also, look at another great review on Loyal Forex review.
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