Hedging is a forex risk management strategy that is used to minimize risk of silver trading online in the forex market. Through the use of a forex hedge trading strategy traders try to reduce their risk by making trades that cancel each other out. It aims at leveling the risk so that the probability of earning a loss equals that of earning a profit from the trade.
Although it is not a perfect, hedging does lower risk to a great extent. If used wisely it can turn an unfavorable outcome in your favor allowing you to earn a net gain from the trade.
There are two basic types of hedging in forex market – direct and indirect hedging strategy. Here we will reveal more about these hedging strategies. You will learn how these hedging strategies can help you in minimizing risk on silver trading in the online forex market.
Direct Hedging Strategy
Direct hedging allows you to place the same forex hedge strategy on a silver currency pair. You take both long and short position on the same currency pair in order to minimize or reduce the impact of unfavorable movement of prices. The net profit you earn from the trade remains zero as long as you have both trades open at the same time.
In order to make a direct hedging, you buy a currency pair and then at the same time sell the same pair in the forex market. If you time the market just right, you can even make more money from the trade without incurring additional risk from the trade.
It is a simple forex hedging strategy that allow you to take opposite direction of your initial trade without closing the account. Both the trading account remains open. The advantage of using this strategy is that you will not incur any loss as the silver currency price moves in opposite direction. Using this hedging strategy, you are able to make profit on the second trade. When you predict that the market is going to reverse and go back to your initial position, you can stop the hedging (second) trade and earn profit from the first trade.
Indirect Hedging Strategy
Recent forex regulations in the US do not permit direct hedging. You cannot go long and short on the same currency pair in the same account. However, there is a technique that US traders can use to hedge silver and other currency pairs in the forex market. It is not a direct hedging technique per se, but still it helps in minimizing the loss of risk of silver trading online in the forex market.
Indirect forex hedge strategy entails using currency pairs that are negatively correlated with each other to gain from the trade. There are certain currency pairs whose prices move in opposite direction during any particular period. For instance, XAG, XAU, AUD, NZD, CHF move in the same direction, while USD, EUR, GPY tend to move in the opposite direction duris expected to move in opposite direction contrary to your expectation. In this situation, you need to go short on a currency pair that is negatively correlated to this currency pair. This will allows you ing a particular period. The two groups of currency pairs are negatively correlated to each other.
Suppose, you want to go long on the XAG/USD currency pair. However, later you realize that the silver currency pair is expected to move in opposite direction contrary to your expectation. In this situation, you need to go short on a currency pair that is negatively correlated to this currency pair. This will allows you to negate any loss incurred from the first trade. You may even earn profit from the trade if the currency pair values move in the same direction for longer duration.
When you see that the price of the currency pairs reverse direction and move in the direction of the initial trade, you may want to close the hedge pair.
Let’s look at a hypothetical example to better understand the strategy of indirect hedging. Suppose you decide to go long on silver currency pair (XAG/USD) and purchase $50,000 of the currency pair in expectation that the price value will rise. After purchasing the currency pair, you realize that you have made an error and it is expected that the currency pair will move in the opposite direction. In this scenario, you need to go short on a negatively correlated currency pair e.g. USD/EUR and order $50,000 of that currency pair to offset the probable loss from the first trade.
Now suppose that the currency price value of second trade moves upwards by 50 pips from 1.0035 to 1.0045. Since, silver is negatively correlated to the USD/EUR currency pair, it will move in the opposite direction. You should let both the trade accounts open until the price trend reverses its position and starts to move in the direction of the first trade. At this point, you can close the hedging currency pair i.e. USD/EUR.
Apart from looking at the correlation of the currency pair, you should also look at the volatility of the pair. Some currency pairs, for instance EUR/JPY are extremely volatile. The JPY currency pair is known to be extremely volatile due to which you should not use the currency pair for hedging purposes. When hedging silver currency pair, you should look for negatively correlated currency pairs with stable price movements.
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