Imagine walking through a flea market on a busy Saturday morning. You look up at the sky and predict that the sun is going to come out strong, so you will likely need sunglasses on your way home. Unfortunately, you left your sunglasses at home. When you come across a table selling sunglasses, you tell the seller that you would like to buy a pair.
After paying for the glasses, you look up at the sky and notice some clouds. You still think you will need the sunglasses, but it's risky because those clouds tell you that the sun might not come out as strong as you previously predicted. There's a chance the weather could turn against your original prediction. You don't want to waste money on glasses you may not need, so you tell the seller that you would like to negotiate a buyback price just in case you don't need them after all.
You are negotiating a deal in which you have the right to buy or sell the same pair of sunglasses at a set price point. You can go either way, depending on how bright the sun is when you are ready to leave the flea market.
This is the type of deal you are negotiating when you use hedging as a Forex strategy. You buy a position on the market based on significant study of the charts and other information regarding the currencies involved. If there is enough risk that the market may turn against that position unexpectedly, you can open a trade to sell that same position without closing the first. You have simultaneous trades to buy and sell the same position.
Forex hedging is a strategy that can help you minimize the risk involved in some trades. If you open a position and feel that the risk is high enough, you may decide that it is worth opening a second position that could reduce the impact of any loss suffered in the first position. This doesn't eliminate all risk, but it can give you some security in a chaotic market.
Once you hedge a position, you have to watch the market closely in order to close the best position at just the right moment. You may decide to close the initial position, accepting a loss on the trade. This allows you to reinvest in a better position noting the current market. You also have the option of closing the hedged position at just the right moment in order to minimize or avoid the loss.
Determining which position to close requires an investment of your time and a strong Forex risk-management strategy. You need a comprehensive understanding of how the market works and comfort watching the charts and using other tools to make predictions and pick up on subtle market changes. This is why most Forex beginners don't get involved with hedging.
Just as most flea market sellers would never allow you to hedge a purchase, not all Forex brokers allow hedging on their platforms. If you find this Forex strategy intriguing, make sure you sign up with a hedging-friendly trading platform.
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