Hedging is one of the most misunderstood trading methods in the world.
So in this guide, I’ll give you the facts about Forex hedging, so you understand what it’s really about. I’ll also dispel the common myths about hedging.
Then most importantly, I’ll show you how I utilize hedging in Forex.
Alright, let’s jump into it…
What is Hedging?
Hedging is a trading method where traders can potentially hold both long (buy) and short (sell short) positions at the same time. This is done to lower risk and take advantage of market conditions that may be harder to trade with one-sided positions alone.
Large multinational corporations primarily use hedging to manage their risk associated with currency rate fluctuations and changes in commodity prices.
But independent traders like us can also utilize hedging to profit from market fluctuations.
The Benefits of Forex Hedging
You can hedge in many different trading markets.
However, Forex provides some of the most favorable conditions for hedging.
First, transaction costs in Forex are relatively low.
Forex Traders usually only pay a spread, or a spread plus a small commission.
Second, Forex is the largest market in the world, so you’ll usually get the price you see on the screen.
Other markets don’t have that many market participants, so you may not be able to get a good price on your trades.
Next, it’s equally easy to go long and short in Forex.
In other markets like stocks or crypto, it’s not as easy to go both long and short. It’s much easier to go long in these markets.
Finally, it’s possible to trade very small lot sizes in Forex, making it possible to hedge if you have a small account.
This makes Forex hedging accessible to more people, compared to hedging in other markets.
How Does Hedging Make Money?
The next question that people ask is:
If hedgers have a long and short position at the same time, then how do they make money?
What critics of hedging miss is that you don’t need to have the same sized short and long position on at the same time.
Traders can do a partial hedge or utilize no hedge at all.
When positions are not fully hedged, that allows you to take advantage of directional moves.
However, if price does not do what you expect, then you can do a full hedge to stop further losses. At that point, you can clear your head and reassess your options.
In addition, you can potentially make money from both hedged positions, instead of taking a hard loss with a stop loss on just one position.
…and that’s one of the many benefits of hedging.
How to Hedge in Forex
You should develop your own hedging methods, but this is what I do.
My hedging method is very simple, but also very powerful.
It’s a simple 5 step process:
- Identify major support or resistance (S/R) zones
- Place a trade as enters the zone
- Place a take profit at the next minor S/R zone
- If I’m wrong about the direction, I hedge the trade
- I leave the hedge in place and look for another trading opportunity
There are several nuances that I take into account when looking to enter and exit trades, but that’s the basic idea.
To learn more about how I hedge, take my course.
Examples of Hedging
Now these concepts may be a little hard to understand without some illustrations.
So let’s dig into the charts so you can see some examples.
Like I mentioned above, I look for solid support and resistance levels.
This is the type of zone I look for.
In this case, I would be looking for price to bounce, so I might look for a buy somewhere inside the green zone.
As the chart moved forward, it turned out that I would have been wrong about the trade.
So when price closed below the zone, I would have hedged 100% with a short. In other words, if I had 1 standard lot long, I would hedge with 1 standard lot short.
In this example, price moved both above and below the green zone, giving me opportunities to close both the long and the short at a small profit.
Not all trades work out like this, but it’s a good example of how hedging can have advantages over stop losses.
If you still have questions about how hedging works, here’s a video that shows more hedging in action.
In this video, I use backtesting software to speed up the process of practicing hedging.
This is a process that I highly recommend doing before ever risking any real money.
Is Hedging Better Than a Stop Loss?
One method isn’t inherently better than the other, it just depends on your trader personality profile.
Some people prefer stop losses because it gives them a hard exit and once they are out, they have a clear head and can focus on finding new trades.
I personally use both methods.
But I use hedging as one of my trading methods because I find that it’s a lot more flexible and not as stressful as using a stop loss. Instead of taking a loss right away, I can work my way out of trades where I wasn’t right about the initial direction.
You can read about all of the pros and cons of each method in this article.
So if you’re interested in hedging, I would suggest trying it out in a demo account or simulation software.
See if you like it and if you want to continue mastering it.
The Best Currency Pairs to Hedge
The best pairs to hedge are going to be the Forex pairs that have the lowest net swap.
In Forex, long and short positions pay or receive separate swap rates, or the daily interest charge or credit, as a result of holding an open position.
If you’re paying a lot of daily interest to hold a position, then that will obviously eat into your profits.
You calculate the net swap by adding the long swap and short swap rates.
This information is available from your broker, or you can get it in your trading platform.
In MetaTrader, right-click any market in the Market Watch window, then go to Specification.
Scroll down and you’ll see the long and short swaps.
In this example:
- Long: -5.628
- Short: -1.765
Therefore, the net swap is: (-5.628) + (-1.765) = -7.393
So if you hold an equal long and short position in this pair, you won’t be losing too much money.
Therefore, this is a good pair to hedge.
As this is being written, I consider anything greater than -8 is tradable. This may change in the future.
On top of that, most brokers don’t have a margin requirement if you have a fully hedged trade.
To learn more about Forex hedging swaps, and what makes a good swap, watch this video.
Get the MT4 EAs here.
Common Forex Hedging Myths
Like I mentioned in the beginning, hedging is one of the most misunderstood trading methods. There is a lot of BS floating around the internet about it.
So in this section, I’ll address a few of the most common myths about Forex hedging.
You Cannot Hedge if You Live in the US
It’s true that there are specific rules around hedging in the US.
However, you can still hedge in a US account, while still following the rules.
There are 2 hedging rules in the US:
- You have to exit the oldest open trades first
- You cannot go long and short in the same account
What many people miss is that there are exceptions:
- You can exit older trades first, if they are of a different lot size than the newer trades. This can be easily achieved by using nano lots. You can also exit an older trade if it’s in a different currency pair.
- You can setup 2 sub accounts under your primary account. Take longs in one account and shorts in the other account.
That’s all there is to it.
There is some thought and practice required, but it does work.
I’ve been doing it for years.
Here’s a video that shows you the concepts in action.
You Can’t Make Money with Hedging
As I demonstrated above, it’s certainly possible to make money with hedging…IF you know what you’re doing and have trained extensively.
Again, the key is know when to hedge and how much.
If you hedge 100% every time, then of course you won’t make any money.
However, there are times when you might not hedge at all.
Or you might hedge only 50%.
That’s the beauty of hedging, it’s much more flexible than one-and-done stop loss strategies.
Hedging is No-Loss
Some content creators will tell you that there are certain hedging methods that have 100% winners.
This is simply not true.
There are hedging methods that have very high win percentages, but it’s simply not possible to have all winners.
When you learn how to hedge effectively, you can close out a series of trades at a net profit, at a relatively high success rate.
If you want to learn more about why this is a myth, read this article.
Learn 7 More Forex Hedging Myths
Those are just 3 of the common hedging myths out there.
To learn the other 7, watch this video…
What if I’m Wrong About a Hedging Trade?
As I mentioned above, there’s no way to have 100% winning trades in hedging.
But there are ways to get out of a losing trade without having to resort to a stop loss.
The first thing I do if I’m not sure about where price is going is to hedge 100%.
Then I look for other opportunities or more clues about where price could go.
If I have a good idea of where price will go, I have a total of 8 ways to get out of a hedging trade.
I’ll share one with you here.
This method might seem a little counterintuitive at first, but demo trade it on a chart and you’ll start to seen when it can work.
What I share in this video is one of my most used hedging exit methods.
Can Hedging be Backtested?
Yes! I highly recommend practicing on backtesting software and a demo account before you ever risk real money.
Since hedging is so discretionary, you aren’t backtesting a hard set of rules, but you’re more getting a feel for what to do in different market conditions.
I suggest using backtesting software that has the “forward test only” feature. This feature doesn’t allow you to move back on the chart, only forward.
When you use this feature, you cannot “cheat” and go back once you have seen what happens in the future.
This is the best way to simulate live market conditions. You will probably blow out your backtesting account the first few times.
But don’t get discouraged, this is normal.
Keep at it and you’ll start to get the hang of it.
This is the software I use to practice hedging.
Final Thoughts on Forex Hedging
Forex hedging can be a great way to trade because it is very flexible and can lower your stress, compared to stop loss based trading strategies.
I love it.
But just like any other trading strategy, it’s not for everyone.
Learn it in a demo account and experiment with the ideas in this guide.
If you want to learn my complete hedging method that I’ve developed over 10+ years of live trading, click here.