Every trader of wants to get a stable benefit, but not everyone thinks about the risks and how they can be limited in their trading. Today’s article will be devoted to the possibility of using hedging strategy.
Using strategies in the dynamic world is a must. With such a variety of strategies, it becomes a matter of personal choice when it comes to choosing which one to use to make big benefits or limit fatal losses. Some of these strategies are geared more toward professional, experienced traders, while others are geared toward beginners, giving them a simple method to use.
A good example of these strategies for beginners is the hedging strategy, which is one of the most popular in community; one with a number of regular users relying on it; users that range from inexperienced to advanced traders.
The principle behind the hedging strategy for trading is to open multidirectional trades in the same financial asset with the same contract expiration time, but with different entry points into the market.
What is a hedging strategy?
Before placing it in the context, we must first examine the meaning of hedging itself. Simply put, hedging means mitigating, controlling or limiting risk. Hedging in real life is, for example, buying insurance for your home to act as protection against weather disasters or thieves.
A similar concept applies in the trading strategy. A hedging strategy allows you to execute put and call options on the same asset at the same time. This is mainly used in volatile markets that are sensitive to the environment and easily influenced by related events.
The idea is to cover both possible outcomes at the same time to prevent you from losing all of your invested money. Either way, at expiration, there will be a benefit on one of the trades, and you are guaranteed a moderate gain or, at worst, as little loss as possible. So basically, in the world, a hedging strategy is your bankruptcy insurance.
Where can hedging strategy for be applied?
The number of ways to use this particular hedging strategy is virtually unlimited: from commodities to currencies; almost everything in the market can be hedged. In fact, currency, as one of the most traded assets, is subject to hedging on a daily basis. Currency pairs, such as EUR/USD, fluctuate wildly, which lays the foundation for an ideal hedging strategy.
Regardless of what you decide to focus your hedging strategy on, one thing remains crucial: observing the market is something you cannot proceed without. Follow the news, be aware of all the things that can affect the price of the asset you are trading, read the charts carefully, analyze statistics and always, always make only informed decisions!
Securing a benefit with as little risk as possible is the ultimate goal for every trader, and as we mentioned above, there are different methods and techniques to achieve this goal. From the simple and easy to use to the more complex and difficult to understand, these methods, combined with careful market analysis, can be a lifesaver when applying trading strategy.
Below are two hedging strategies for described.
The first hedging strategy
The purpose of this version of the hedging strategy for is to save the result of the transaction from the maximum loss. Most often, such a situation can occur when trading at the levels of the trading asset trend. For example, in trading on the EURUSD currency pair, the trader enters into a transaction on a rebound from the trend level with the prediction of price movement DOWN and expiration time of 3 minutes, but the quotes pass not enough distance in that direction and make the breakdown of the level, continuing its movement upwards. This is a case for hedging – when the price reverses and starts moving back to the trend level, an upward hedging strategy when trading (with an opposite forecast) is concluded. This is what it looks like on the chart:
No matter how the situation ends up in the market, the trader will be able to reduce his loss to 20%, which is much better than losing the entire amount of investment. Even if the price reverses, the trader will make a benefit on one of the trading positions.
The second hedging strategy
This variant of hedging strategy, except for minimization of losses, also allows to receive additional benefit. Often one can observe in the course of the trading process a situation when after conclusion of a deal with the prediction set on the asset quotations chart an impulsive movement takes place which moves the open position to the benefitable zone. But then the impulse fades and if the expiration time is still far away, such a trade will most likely close with a loss. To save the trading result it is better to apply hedging strategy, namely – to conclude a new deal with a forecast opposite to the first deal.
Concluding transactions using such a mechanism, you can get the following result:
- If at the time of expiration, the price of the asset will be between the levels of the concluded transactions, then the trader receives a benefit of 80% on each transaction. That is, if the sum of trade bets was 100 USD, then as a result the total income will be 160 USD.
- If at the expiration time the price of the asset fell back and was below the original up trade, then the resulting amount of loss will be only 20% instead of the possible 100% that the trader would have received without entering into a hedging trade. That is, the hedging transaction DOWN managed to save the trading result on the original trading position.
- If at the expiration of the expiration time the price of the asset has risen above the level of opening of the first trade, that is, justified the forecast made by the trader, then the original trade will close with a benefit and as a result the trader will receive only 20% of the loss. This option is the only negative outcome of hedging.
Using the second method will allow the trader either to reduce the level of losses to a minimum, or receive a double amount of income. And it can be called a good trading result, especially taking into account the fact that the probability of getting double income is about 70%.
When applying the principle of insuring trading positions, you must remember that, above all, its main purpose is to reduce the number of losses, which will eventually allow you to get the maximum benefit in trade with minimal losses. Therefore, you should not use it only as the main trading approach. It is best to use the hedging strategy in conjunction with the main trading strategy used in day-to-day trading, where it will virtually eliminate losses from trading.