Hedging as a strategy

Hedging as a strategy

Hedging is an insurance against the risk of price changes by means of holding the opposite position at the parallel market. Hedging gives an opportunity to secure yourself from the possible losses by the time of forward deal settlement; provides the raise of the commercial transactions flexibility and efficiency; provides the cost cutting for the trade financing by the real commodities; allows to reduce risks of the sides: the losses from the commodities price changes are balanced out by the profit on futures.

As a rule, losses stop their development upon reaching the stop-loss, or in the case, the price reversed and went to the appropriate side. These variants are well known for everybody, and there is no point to consider them. The thing is that the person who does not use the Money Management is overrating his/her abilities at least, but the trader who does not use a risk-management always attacks, but he/she can not defend!

Hedging at Forex is an obligatory element of the protection against the risks and following the position for the purpose to make profit from them. The simple example: you have opened the sell position, basing on the MACD indicator of the EURUSD tool. Further you have received profit for three times , but now the price is going upward and your losses have not been reducing for more than twenty four hours. Here we have the situation for the hedging, but how to do it correctly? The mathematic and analysis will help us to do this.

The position locking is also a well-known tool and is at least ineffective, and furthermore is a self-deception; moreover this lock is always with a negative swap, because the positive swap on the pair is less than negative one. As a result, this action differs a little from the position reversal in reliance on movement’s continuation, and then for its full return to the first position’s point.

Thus, the reason for any losses is an unpredicted currency’s movement (we are talking here about the currency market). In particular, the currency’s movement and not the currency pair move! If you see at other charts that the reason for losses on the sell position of the EURUSD pair is consisting in the dollar reduction, then it is more likely to earn on this situation by the assets transfer to the other currency pair without the US dollar.

To do this, it is necessary to determine the following:

1) The pair or pairs which are correlating well with the EURUSD pair.

2) This tool/these tools should be more volatile than the first one in order to the profit outgoes the losses.

3) To open the opposite position/positions on the US dollar. BUT!!! In equal shares.

It can be important, because the EURUSD lot is not equal the GBPUSD one. Here is a price difference for a point (for example, for the USDJPY pair) and for the volatility of one or another pair. These factors should be taken into account for the effective transfer of the position for the other pair. In other way, the disagreements can become too serious, because the initial balance is important for us, and only after it - the advance on the increment in profit against the losses. The further goal is to achieve the “swing” effect after rally ends, making losses on the EURUSD pair and outrun the profit on the GBPUSD.

After the strong movement the period of consolidation is started and at a given moment the loss on the first pair is additionally reducing. At that moment you have great chances to come out of the position with profit, and if the total swaps are positive, which is also important, that will give you the additional support. In fact, the present method can be used for transfer of the invested assets to the EURGDP pair. The simple example of two pairs was discussed here, however, there can be used more complicated combinations with the usage of additional currency pairs for achievement of better results according to the portfolio closing facts.

In order to determine the correlation score the algorithm on the formula of the simple correlation is usually used, which you can find in the attachment along with the indicator for MT4, where it is realized to the full. It also can be noted that hedging methods are extremely various, because even in this example the pairs without major currencies could be used, but at that the spread on profit/loss could be higher. The most important thing in hedging is the achievement of the needed balance, by means of assets diversification.

Types of hedging.

Classical hedging

Classical hedging is a hedging by means of holding the opposite positions at the market. The first type of hedging was used by the dealers of the farm products in Chicago (USA).

Full and partial hedging

Full hedging supposes the insurance against risks for the whole sum of the deal. The present type of hedging completely excludes the possible losses, connected with price risks. The partial hedging is insuring only the part of the real deal.

Anticipative hedging

Anticipative hedging supposes the purchase or sale long before the settlement at the spot market. At the period between making the deal at the time market and the settlement at the spot market, the futures contract is as the substitute of the real commodities' delivery contract. Also the anticipative hedging can be used by the means of purchase or sale of the urgent deliverables and its further execution through the stock. The present type of hedging is the most popular at the stock market.

Selective hedging

Selective hedging is characterized by the fact that deals at the futures market and spot market vary in the volume and transaction time.

Cross hedging

Cross hedging is defined by the fact that a deal with contract not for the underlying asset of the spot market is executed at the futures market, but for other financial instrument. For example, there is a deal with a share at the real market, but at the futures market - with futures for the stock index.


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