What Is Forex Hedging?

Forex hedging is a situation where you carry two offsetting positions in your account to lessen your risk in the event that things go against you. In brief, that means that you enter into a second trade in order to protect an existing position from negative events.

This sounds like a great way to get into a win-win situation but it does have its costs. In the first place of course you have to take into account the spread or transaction fees on the two positions. Calculating the cost of this and balancing your hedge requirement can be rather complicated.

Also of course by reducing your risk you are also reducing your chance of profits. Assuming your original trade goes well, the hedge position will lose, so that overall you make less money than you would have. For this reason it is not something that the average trader does all of the time. However in some circumstances, such as where you fear something may be about to happen that will overturn a current trend, you might decide it was worth doing.

It is possible to offset one spot forex transaction with another spot transaction in order to hedge it. However, this is often not ideal because of the short term delivery time of spot contracts. If you want to protect your original position for any longer you have to find another way. The most popular way is to offset with a foreign currency options contract.

As of May 2009, hedging was banned by the NFA (National Futures Association). Most reputable US brokers are members of this association which regulates forex as well as and other financial trading brokers. This means that if you try to operate a hedging trade, your broker will close it out. Usually this happens automatically.

A way around this if you like to use forex hedging systems within the same account is simply to set up with a broker in another country where it is still allowed by the regulatory bodies. This includes the UK at the time of writing. Many of the larger brokers have a UK branch since London is the biggest currency trading floor. So you can simply ask them to transfer your account to their UK office. If they cannot do this, you may have to switch to a new broker. If trading with forex hedging was your main way of making money it is probably worth doing that.