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A Question on Hedging

A Question on Hedging

2011-04-21 02:13:00
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 moneyInstructor’s Response:Good question...

Not to be glib, but in our opinion the best way to avoid hedging issues is to not hedge in the first place.Consider your reasons for opening the short position and putting on the hedge: you were in a losing trade. The hedging decision was solely based on the emotions generated by being in a losing trade and not willing “to accept the loss”. This is an excellent example of how emotions can get the better of your judgement while trading.

On the other hand, if a trader performs a solid analysis and enters into a trade after having identified a strongly trending pair, takes the trade in the direction of that trend, places prudent stops and limits based on solid Money Mangement, there is no need to hedge. Knowing that you have entered into a higher probability trade, if the market moves against you, you simply accept the loss and move on.After all, we don’t have to like losses but we do have to acknowledge that they are a very real part of trading.

All things considered, we do not recommend buying and selling the same currency at the same time.

Hedging can't help us escape the hard realityof the risk-return 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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