Hedging – Is This Advisable?

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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. Spot contracts: These are the normal types of contracts placed by the retail forex trader on a day to day basis. Because spot contracts are usually short term they are not the preferred method.

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.

Benefits of Hedging

-Hedging using futures and options are very good short-term risk-minimizing strategy for long-term traders and investors.

-It can be used for capturing profit.

-It enables traders to survive hard market periods.

-when utilized correctly it can shield you from commodity price changes, interest rate changes, etc

-It is not time-consuming for the long term trader since it doesn’t require daily monitoring.

-Hedging using options provide the trader an opportunity to practice complex options trading strategies to maximize his return.

Cons 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 performing well or moving sidewise, then it offers little benefits.

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. And this risks can lead to huge losses. And so before deciding to utilize it you must understand its underlying concepts adequately.

If you are one of those fresh traders who may want to jumpstart your own career, you may now find out and study everything by finding out about the best forex trading strategy for you.Have a look at ForexYard review for a great broker suggestion.

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Topics: Investments | Comments Off

Tags: Currency Trading, Finance, forex, hedging, investment, Investments

Article Citation
MLA Style Citation:
Johnson, Matthew "Hedging – Is This Advisable?." Hedging – Is This Advisable?. 8 Feb. 2012. uberarticles.com. 21 Apr 2012 <http://uberarticles.com/finance/investments/hedging-is-this-advisable/>.

APA Style Citation:
Johnson, M (2012, February 8). Hedging – Is This Advisable?. Retrieved April 21, 2012, from http://uberarticles.com/finance/investments/hedging-is-this-advisable/

Chicago Style Citation:
Johnson, Matthew "Hedging – Is This Advisable?" uberarticles.com. http://uberarticles.com/finance/investments/hedging-is-this-advisable/

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