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Brokers for Hedging: Understanding the Strategy, Its Significance and Potential Profits
Hedging is an approach in forex trading where a trader opens an additional position in the opposite direction using the same or a different instrument to protect an already open position. It serves as a safeguard against potential losses.
Not all brokers encourage hedging; some even prohibit it, while others provide compensation mechanisms. If a trader opens a position in one direction and then adds another position using the same instrument but in the opposite direction, the first position will be closed due to this mechanism.
Direct hedging (opposite trades on the same asset) is often prohibited by Russian dealers due to the specific nature of the forex market. In forex trading, when a trader enters a position, they exchange one currency for another. Reversing the position would lead to mutual execution, which the forex mechanism does not support.
A workaround is the use of force preservation, allowing traders to keep the first position open while placing an order in the opposite direction. A top-notch hedging broker offers this option.
Mutual execution does not occur if the trader’s first position has a stop-loss. This order dictates when a trade should be closed. However, stop-losses are visible in the order book. A large broker may attempt to manipulate them, lowering or raising the asset’s value.
Brokers for Hedging: Who Can Provide the Entry Ticket?
Hedging can be done with any broker, especially if using a multicurrency approach. This involves opening two positions on different correlated assets.
For example, strongly correlated pairs are:
- Euro-dollar (EUR-USD)
- Pound-dollar (GBP-USD)
A trader can open a buy position on one pair and a sell position on the other. This technique qualifies as hedging and is completely legal. The broker won’t raise any concerns.
Inverse correlated pairs move in opposite directions. Examples include EUR-USD and USD-CHF. Hedging can be confidently executed in the same direction using these pairs.
Note: Not all brokers support hedging. Apart from the legality of hedging, the trading conditions are crucial.
A top hedging broker offers low commissions since a trader opens two positions, one of which results in a loss while the other compensates for it.
Profits may be minimal due to commissions. High commissions for both positions could significantly impact the trader’s account.
Many brokers profit by widening the spread by a few pips. This approach allows them to forgo commissions, making them ideal for the forex hedging strategy.
A top hedging broker should also:
- Permit the use of robots, as many strategies are automated. Robots allow rapid entry into protective positions, reducing losses.
- Offer narrow spreads. A broker with excessively wide spreads can make it difficult to profit from both positions.
To make hedging effective, a diverse pool of assets is vital. Locking risks isn’t limited to currencies; different market assets are involved.
For example, a certain type of oil and stocks of the corresponding extracting company correlate. When oil prices rise, stock prices follow suit and vice versa. A broker offering a broad pool of assets simplifies finding suitable pairs for hedging.
Note: Delays must be considered. Unlike currencies, assets in other markets might react slowly to each other. This delay can also be turned into profit. After oil prices rise, stock prices may not immediately follow suit. The rise becomes visible after some time.
Our brokers for hedging rating consists of thoroughly vetted intermediaries. They provide a secure trading environment and hold licenses from strict financial regulators. Without such regulation, even the most protected strategy can be rendered useless.
When to Embrace Hedging
Hedging is most effective when minimizing losses from unfavorable positions. For instance, if an asset isn’t moving as desired, hedging can potentially turn the situation around, yielding profits or at least breaking even.
Various hedging strategies exist. For instance, before the London trading session starts, a trader can enter two opposing positions with tight stop losses.
During the London session, specific assets (e.g., pairs involving the pound) usually show significant movement. In this case, the losing trade closes itself, and the profitable one remains open.
Every trader should understand that locking positions isn’t always advisable, particularly for short-term positions.
Hedging is most effective over medium to long distances. Short distances carry the risk of encountering flat market conditions, resulting in two unprofitable trades.