Hedging Forex

The very concept of Forex hedging is directly similar to risk diversification. However, it is not necessary to draw sudden conclusions – the goals of these concepts are identical, and the ways to achieve them are different. Risk hedging involves the protection provided in advance against various fluctuations in the quotes of trading assets.

This method makes it possible to ensure against surprises associated with trading in the currency market. The closest to the concept of «hedging» in meaning is the word «insurance». Hedging is used almost everywhere, but in the foreign exchange market, it becomes quite specific. Trader ensures their deal by making others.

What methods of hedging can be used?

Depending on the purpose, there are two types of hedging the risks: exchange and over-the-counter one. The first is made with the help of various swaps and forward contracts, and second, by using futures and options. You will understand them, having started direct trade.

According to the implementation of hedging, methods can be divided into classical, complete, partial. There are also perspective methods known. Further, they will be discussed in more details:

•    classical hedging is also referred to as «pure» hedging. This method is as transparent as possible. In order not to lose the money spent on a trade, a trader opens two positions in the market immediately, which differ in the direction. If the forecast falls short of expectations – the losses will be at least partially compensated.

•    in case of partial or full hedging, the purchase is covered only partially. This option is used by confident traders who do not want to spend a lot of money on commissions.

•    risk minimization using advanced hedging is used exclusively by experienced professionals in the foreign exchange market.
What types of hedging strategies exist?

A well-chosen strategy will help to achieve the best result when hedging the risks in the Forex market. You need to focus on the time of trading sessions or focus on the news – under any circumstances, your method of hedging risks should be directly related to the trading strategy. In addition, there are generally accepted strategies for hedging that differ in how the idea is implemented.
The futures contracts can be one of the instruments of hedging. Options are often purchased.

Futures contracts as a safety tool

What is the advantage of futures or futures contact? It allows traders to trade a specific currency pair at a time when it is needed, but at the price of the current market. In other words, when buying futures, you give yourself the opportunity to sell it in the future at a price that is set today. You probably already guessed how futures are used for hedging.

The total volume of your current trade you wish to insure must be identical to the number of futures contracts you have purchased. If the quotes go in the other direction, you will be able to hedge the risks of selling the purchased futures contracts. Everything is very simple and clear.

Examples that will allow you to understand the subject better

The most common example of the use of hedging the risks, which makes it possible to embrace the essence of the mechanism, is the example with the grain production expenses. Let's assume you have an agricultural business. You are engaged in growing crops and are highly dependent on the weather conditions observed in your region. If there will be extremely poor harvest season – you will have to increase prices, and if there will be an overabundance of the product, you will give the products for a song. In order to stabilize business development, such risks are unacceptable.

What to do in this case? To do this, there are contracts that directly note down the price of the product and the period during which it will operate. Thus, once signed contract for the supply of grain at a certain price will allow selling grain without losses.
Another example is also related to business.

You sell grains and change the value depending on the US dollar rate. At the same time, the volatility of the Forex market makes the price extremely unstable. Then the contract is entered into the rate that is used within the validity period, which regardless of the existing dollar exchange rate will be calculated with your partners. These are real-life hedging examples that reveal the essence of the mechanism.