Hedging

Hedging is a way of protecting one’s position against an unfavorable market move. Usually, traders use this strategy when they are concerned about some event on the market that can cause high volatility. To place a hedge means to open an opposite position of the same size on the same trading instrument.

How does it work?

For example, a trader has an open buy trade on EUR/USD, and he wants to protect it from possible losses so he places a sell order of the same volume on the same instrument. Thus, if the buy deal turns out to be losing, the sell deal will bring profit. This type of protection eliminates the risk but at the same time, the potential profit also gets reduced.

It may seem that selling and buying a currency pair simultaneously is a rather strange move because two opposite deals offset each other. However, hedging makes sense when it comes to long-term trade. Instead of closing a position ahead of some key market event that can cause a trend reversal, a trader can place a short-term hedge, thus easing exposure to the risk of sharp price fluctuations.