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The Case Against Hedging

By Richard Krivo, Trading Instructor
25 October 2011 23:52 GMT

Every few weeks a question comes up about hedging…buying and selling the same currency pair at the same time.

It usually starts something like this…

The trader opened a trade and after a time the trade had moved against them. Rather than take the loss, (one individual said the loss was simply “too big to accept”) the trader decided to open a trade in the same pair going the opposite direction. That way the losses that they would incur should their original position continue to move against them would be mitigated as the trade in the opposite direction moved in their favor. At the outset, it almost sounds like a good plan.

What happens however when the market starts to move against the second position?

Since the trader was carrying a loss that was “too big to accept” on the first position when the second was opened, as the market moves against the second position, the trader will now have two losing positions on their hands. It is usually at this point that we receive an email from the trader or a question in our live webinars on how to “unwind” this hedge profitably. (They are still not willing to accept the loss.)

Not to be glib, but my response is always not to allow yourself to get into this position in the first place. The easiest way out of any problem is not to get into it in the first place.

Consider this trader’s reason for hedging: they were in a loss that had become too large and they were reluctant to close out the position and take the loss. This is a good example of letting emotions win out over good judgment. The best time to make trading decisions is before the trade is ever entered since at that time there are no emotions involved…you have no “skin in the game”, so to speak. So, lay out your trading plan ahead of time and then stick with it.

Trading with the trend is one of the best strategies to employ.

Rather than hedging, we would either be buying or selling a currency pair based on our interpretation of the direction of the trend on the daily chart. Look only for the pairs that are in the strongest trends to trade and then trade them only in that direction.

Any solid trading plan will always include the principles of Money Management. Entering the trade in the direction of the trend with a stop in place that does not over leverage the account and having a limit (profit target) in place that at least will gain the trader twice the amount they have at risk, is a solid plan.

By doing this, emotional decisions are removed from the situation. Your trade will either be stopped out with a manageable (acceptable) loss or it will limit out with a profit. The question of hedging will never cross your mind.

We do not recommend buying and selling the same currency at the same time…period.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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25 October 2011 23:52 GMT