You’ve probably used the terminology “hedging your bet” a few times in your life. Perhaps you wanted to “hedge your bet” by purchasing more life insurance when your lifestyle improved or before you entered your 40’s. “Hedging your bet” is a similar concept in both the stock market and Forex market. Basically, it means playing it safe by protecting yourself against any possible losses. Losses might occur anytime you trade on a Forex trading system, but it’s wise to lessen or hedge your bet in certain situations.
How does it work?
Hedging is rather simple to perform - you buy and sell in the same currency pair at the same time. This limits your risk in case of market fluctuations. Let’s say you want to buy one lot (100,000 units) of EUR/USD on a Forex trading system. You’re not sure if the euro will strengthen in the upcoming month so you decide to hedge your bet by placing an order on the Forex trading system to sell one lot of EUR/USD. Now you’ve limited your risk by placing a hedged bet.
Let’s say that you decide to sell one lot (100,000 units) of EUR/USD. The value at the close of trade is 1.5887. You’re a bit worried that the euro might weaken so you decide to hedge your bet or sell one lot of EUR/USD, at the rate of 1.5890. Now, if the euro rises, you earn a profit in the buy position, but a loss in the sell position. On the other hand, if the euro weakens, you lose in the buy position, but win in the sell position. What you’ve just done is limit your overall risk with both buying and selling in the same currency.
Margin requirement
In placing a hedged bet on a Forex trading system, you’re margin requirement is equally divided between the two positions. Suppose you have a margin requirement in a non-hedge trade of two lots (200,000 units). Now, when you decide to hedge your initial bet, your margin requirement is equally divided between the two positions – 100,000 units for each trade.
Hedging seems like a good practice, but risks are involved and overall equity can be reduced by other factors that come into play. For further advice, just ask a customer representative from one of the online Forex
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