What Is Forex Hedge?

33 points

What Is Forex Hedge? The difference between hedging (netting) and hedging is an important factor to consider when choosing a trading account. Depending on the broker, regulations and trading platform, some only allow hedging while others only enable clarification.

The concepts of hedging and netting do not have to be interrelated. The latter is therefore only introduced for better trade management of multiple positions. Risk methods existed long ago and remain a practice in almost all financial markets.

Hedging is a protective strategy that involves the simultaneous purchase and sale of one or more instruments to minimize or reduce losses and exposure risk. So, for example, a person can initially decide to buy EUR / USD and then sell the same pair so that if their long position fails, the short order will cover their losses.

Depending on a few parameters, the investor can close both for a generally reduced loss and for a profit. Before trading software became more advanced; a forex trader naturally had to open two positions, and this was what trading terminals would reflect.

In this accounting system, subsequent positions after the original order are reflected as a new transaction, each with its own volume, stop loss and profit taking parameters.

For those who are hedging, it is necessary to know what their brokers allow, depending on the regulatory and trading platforms. Most brokers will allow hedging or networking.

What Is Forex Hedge?

The MetaTrader 5 and cTrader trading platforms (released in 2010 and 2011 respectively) were one of the first platforms to include clarification. Not all trading software even now includes this feature. Netting consolidates different positions as “net ” or creates a single trading value.

Therefore, with hedging, an investor can open opposing orders on the same instrument in which a trading terminal will account for each of them. With netting, it’s just one position that consolidates it all. In the transaction history, it will show only a single transaction with a total volume (next to it, it usually shows the sum of other orders previously made).

The only difference is that orders of the same lot size cancel each other out. For example, if an investor opens a long and short position worth 0.10 each, the platform automatically closes them.

Netting will take into account the highest lot when trading that is not worth the same position size.

To better understand these concepts, let’s look at two examples of scenarios that reflect both hedging and clarification.

Forex hedging and networking examples
The picture below shows the hedging we see in EUR / USD simultaneously trading at 0.50 and trading at 0.20.

On the same EUR / USD pair, the second image below shows how a netting account will reflect if the transaction opens the same two positions as before. Note that the resulting buy order of 0.30 is a difference (buy subtracted from 0.20 to 0.50).

The netting system will partially cover any profit or loss from the 0.20 sale (shown immediately in the trading history) before reflecting the last 0.30.

Forex Hedge pros and cons
Although some investors do not rule out a few disadvantages of this approach; for several reasons, they may still have problems with hedging. From a graphical point of view, as opposed to networking, the investor can see each entry. Therefore, it makes it easier to change any parameter individually.

It is possible to add more than one stop loss. Or they can take profits for each. There is more flexibility for the investor.

Of course, the main drawback is that if there are too many hedged positions, the investor’s terminal will appear to be clustered. Therefore, volume will make accounting for profits and losses difficult.

Also, knowing the “breakeven point” of all orders requires manual calculation, which takes a lot of time.

Pros and cons of networks
Netting is a better accounting system, primarily for ‘scaling’; (opening multiple positions in the same direction on the same pair). An investor needs to manage only one order for each Sunday in terms of the parameters of stopping losses and getting profits, which are time and energy saving.

In contrast to hedging, it is much easier for an investor to know the “breakeven point” considering all the volumes it performs in a pair. The disadvantage of networking is the opposite of the advantages in hedging.

First, if they have accumulated in a single position, you can’t stop the loss and get the profit levels of the separate positions. Technically, you can’t be protected by netting by opening buy and sell orders of the same size in the traditional sense, and there’s no flexibility when using different volumes.

In addition, only one result, instead of two results, can potentially gain. For example, if a person opens a sale trade of 0.10 and a buy trade of 0.08, only the sale position will remain at 0.20. If the market went against short trade, they would have to shut it down.

If they are using the traditional hedging system, they may close the sell order; or they may allow the buy position to operate.

What Is Forex Hedging After All?
In general, hedging and netting in Forex differ in accounting systems. The former notes many separate positions at the trading terminal, while the latter combines all of them into a separate order.

No approach is better than the other because they serve different purposes. Although slightly more complex, hedging is more flexible. For this reason, it is still a better method to perform traditional hedged trades.

Netting is inflexible in this regard, but it is much more suitable for investors who ‘scale’ their positions. Instead of opening and managing orders of 5 0.1 lots, the system will simply count them as a single 0.5.

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