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To Hedge or Not to Hedge

To Hedge or Not to Hedge

Richard Krivo, Trading Instructor

Student’s Question:If I've opened a long position that's losing money but I've left it open too long to accept the loss. I could hedge it by opening a short position in the same currency pair.But what is a good way to work out when to close the hedge position. Too soon and I might need to open another, too late and I lose money.Instructor’s Response:Good question...Consider your reasons for opening a short position to hedge the long one: you were in a loss that, as you said, you could not accept. This is a good example of letting emotions win out over your judgement. The best time to make trading decisions is before the trade is ever entered since at that time there are no emotions involved. Lay out your trading plan ahead of time and then stick with it.

If you enter into the trade with a stop loss amount and with a take profit amount predetermined, there would be no need to hedge. The trade either stops out with a manageable loss or you take profit.We do not recommend buying and selling the same currency at the same time. Trading with the trend is one of the techniques to have a greater likelihood of success. So we should 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.In a nutshell, hedging can't help us escape the hard reality of the risk-reward tradeoff. A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made. And if the investment loses money, your hedge, if successful, will reduce that loss.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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