Most novice traders focus on finding the “perfect entry” into the market. However, no strategy will give you a 100% result. Even if the analysis is flawless, unexpected news or a surge in volatility can turn the trade against you. This is where hedging comes in – one of the key risk management tools.
Hedging is not a way to double your profits, but a way to avoid losing too much if the market goes in the wrong direction. Simply speaking, it is insurance for your position.
Why Is Hedging Important?
1. Volatility. Forex is the most liquid market in the world, and a 100-point movement can occur in a matter of minutes.
2. News. Central bank decisions, inflation, or labor market statistics instantly change the balance of power.
3. Geopolitics. Wars, sanctions, trade wars – all of these directly affect currencies.
4. For professional traders, hedging is built into their capital management system. It’s like a seatbelt: it doesn’t guarantee that there won’t be an accident, but it makes the chances of survival much higher.
Basic Hedging Methods on Forex
Method #1. Hedging through correlated currency pairs
There are pairs on the market that move almost synchronously or, conversely, in opposite directions. This is due to economic ties, trade flows, and the dollar’s role as a global reserve currency.
Example 1. Direct correlation (EUR/USD and GBP/USD).
Suppose you bought EUR/USD at 1.1500 for 1 lot. But the market is getting nervous ahead of important statistics. To mitigate the risk, consider opening a short position on GBP/USD with a volume of 0.5 lots.
- If the dollar strengthens sharply, both positions will go into the red, but the loss will be smaller.
- If the dollar weakens, the profit on the euro will be greater than the loss on the pound.
Example 2. Reverse correlation (EUR/USD and USD/CHF).
You bought EUR/USD, but you are afraid that the dollar may rise sharply. In this case, you can sell USD/CHF. If the dollar does strengthen, the loss on the euro will be offset by the profit on the franc.
Important: correlation changes over time. Therefore, this method works best in the short term or during stable market phases.
Method #2. Hedging through commodity assets
Some currencies are directly dependent on commodity prices. They are called “commodity currencies”:
CAD (Canadian dollar) – depends on oil (Canada is a major exporter).
AUD (Australian dollar) – sensitive to gold and commodities in general.
NZD (New Zealand dollar) – depends on agricultural exports.
Example 3. Hedging through oil and CAD.
You have a long position in USD/CAD (you are waiting for the Canadian dollar to weaken). However, oil inventory data is about to be released. If oil prices rise, the CAD will strengthen and the trade will go into the red. To mitigate the risk, you can open a long position in WTI. Then the decline in USD/CAD will be partially offset by profits from the rise in oil prices.
Method #3. Hedging with options
Options are a more professional tool available on exchange platforms such as CME.
Example 4. Buying a put option.
You bought EUR/USD at 1.0850, but you are afraid that in the event of unexpected inflation in the US, the dollar will strengthen sharply. You can buy a put option with a strike price of 1.0800. If the euro falls below this level, your loss on the main trade will be offset by the profit on the option.
Example 5. Buying a call option.
Similarly, if you have a short position and are afraid of the euro rising, you can buy a call option.
Options allow you to precisely limit your risk, but they come at a price – a premium that you have to pay. It’s like insurance: it costs money, but it saves you from disaster.
The expiration date of an option directly depends on the specific risk you want to hedge. The logic here is as follows:
- If you are hedging short-term risk (e.g., the release of Non-Farm Payrolls or an FOMC meeting). Take options with a very short life span (from 1 day to 1 week). They are cheaper than “long” options and cover the period when the probability of sharp movements is highest. The downside is that the premium quickly “burns out” if the market remains calm.
- If the position is medium-term (several weeks). It is better to look at an expiration of 2–4 weeks. This will protect the position from several macroeconomic events in a row (e.g., CPI + Fed meeting). Disadvantage: the premium is more expensive than for short-term options.
- If the position is long-term (months). Then you need options with an expiration of 2–3 months or more. This is expensive, but it gives you peace of mind and allows you to hold your position even in periods of increased uncertainty (crises, elections, geopolitics).
Method #4. Hedging with locking
It’s an opening opposite trades on the same pair (if the account has a hedging mode, not a netting). Traders often use this method during periods of uncertainty, like when strong news is expected and they don’t want to close the original position yet.
Example 6. Locking a Trade.
You have a long position on EUR/USD. You open a short position with the same volume. As a result, price movements no longer affect your balance, meaning the positions are “frozen.” Later, the trader can close one part and “unfreeze” the trade when the situation becomes clearer.
However, this method is often criticized: it does not reduce risk, but simply postpones the moment of loss. Even so, it can serve as a temporary tool when markets face high-impact events.
Beginner Mistakes in Hedging
- Hedging too large a volume. If you hedge 100% of your position, you can lose all your profits.
- Ignoring the cost of hedging. Options cost a premium, and commodity assets require margin.
- Lack of strategy. Hedging should be part of a trading plan, not a spontaneous action taken out of fear.
- Relying on eternal correlation. Just because the euro and the pound moved together yesterday does not guarantee the same tomorrow.
Bottom Line
Hedging is the art of balancing risk and return. It requires discipline and an understanding of how different assets are related to each other. But most importantly, it allows traders to preserve their capital and psychological stability.
Professionals know that in the long run, it is not those who guess every turn of the market who win, but those who know how to control losses and manage risks wisely.