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    Risk Management for Beginners
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    Using Indicators
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  13. Technical Analysis (Part 2)
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What is Hedging in Forex?

Hedging is essentially opening additional positions to offset the potential loss of the current position(s). As a rule, the newly opened positions used for hedging are going against the current positions.

It’s important to note that Hedging is ILLEGAL when it comes to Forex within the US!

While Forex hedging seems to be an innocent approach to protect existing positions, it’s actually illegal to apply this strategy in the US. While not all forms of hedging are illegal in the US, the one I just described above is not accepted, as buying and selling the same currency pair is not legal.

This restriction was implemented by the Commodity Futures Trading Commission (CFTC), which requires brokers to have a special order, called OCO (One Cancels the Other), integrated into their platform, which automatically prevents traders from hedging on the same pair.

The CFTC also has the first-in, first-out (FIFO) rule, which obliges traders to liquidate their existing positions only in the order they were initially placed. Thus, all positions on the same currency pairs will automatically be closed when a trader closes the most recent trade.

Elsewhere, hedging is considered to be perfectly fine with most brokers worldwide, including in the European Union, Australia, and Asia.

During hedging, brokers generate twice as much net profit from the spread compared to traders. The main reason why Forex hedging is illegal in the US is because CFTC doesn’t approve the double cost of trading and because that brokers earn more than traders.

For those that are able to in other countries, here are the most popular hedging strategies and approaches:

Hedging Strategy #1

The most basic hedging method is to open a position that opposes an existing position on the same currency pair. Basically, the newly opened position will nullify any movement in the main position and thus should be used to protect against undesirable price moves.

For example, let’s say that you have a long position on a pair, and after a bullish move, the price starts to decline, showing clear signs of a trend reversal. According to this simple hedging strategy, you can open a short position and protect your long. Since you’ll have both a long and a short on the same currency pair, you eliminate all the risk, although you won’t make any profit during hedging.

You may wonder why you cannot simply close the long while the price is declining. Well, some traders hold positions for a long time, like weeks or months, and they don’t want to exit the market. For them, it makes more sense to use the hedge and protect their existing position while the price goes against them.

Sometimes, traders will close the one that’s losing, and then as price continues to head in the direction of the winners, that will be their profit (whenever they decide to close).

*We do not endorse hedging. We are simply educating you on everything that relates to the market.*

Hedging Strategy #2

Another popular hedging strategy is to open new positions on other pairs in an effort to manage the risk on an existing position. Thankfully, this approach is not illegal in the US.

For example, let’s say that you have a long position on the EUR/USD pair, and the price starts to decline, which you don’t like. What you can do is to go short on GBP/USD, which is closely related to EUR/USD. Basically, this strategy implies that you should pick two pairs that are positively correlated and place opposing trades.

In our example, the US dollar is becoming stronger for a while, even though we’re bearish on it in the longer term. By shorting GBP/USD, we leverage the strengthening of the USD and nullify the loss in the EUR/USD pair.

However, this type of hedging carries more risk, as you have to bear the exposure to several currencies, such as the euro and the pound, which may behave differently at any given point. Nevertheless, it’s true that it may sometimes help you make more profit than using the first strategy, which implies a net balance of zero.