Forex Hedging

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Forex Hedging in Forex Trading

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Forex Hedging

In the financial and business world, hedging is probably one of the most common terms we may encounter everyday. Although some may think that hedging is something confidential or highly classified, in truth, almost all Forex traders in Forex trading realm practice hedging. Actually, to make the term hedging to be more easily understood, we can relate Forex hedging to buying insurance in our everyday life.

To make matter simple, hedging in the Forex realm is like buying insurance in order to get oneself insured from accidents such as fire or theft. In Forex trading, hedging is almost the same as buying insurance, the only difference is, hedging does not cover for accident, instead, hedging covers the amount of losses one might sustain in Forex trading. Actually, hedging is quite commonly practiced in the business world where most of the company would hedge in order to protect themselves from losing their profits.
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In the Forex market, hedging is a method practiced by Forex traders in order to minimize their losses. Generally, hedging involves complicated financial instrument known as derivative, and the 2 most common types of derivatives are future and options. With these instruments used correctly, a loss in one of the investment can be offset by a gain in a derivative. In order to better understand how hedging works, let's take a car maker company in the US as an example. After the car company is US manufactures the car, they intend to sell the car in the European market. Each time when they are selling the car, they need to convert the value of the car from the USD to GBP, however, due to the constant fluctuation of the currency exchange rate, the actual value of the car (after converted to GBP) may varies. In order to protect the profit margin of the company from the fluctuation of the currency exchange, the car manufacturer company hedge and fix the conversion rate from USD to GBP at a specific value, thus eliminating the risk of losses due to fluctuation in the currency exchange. Hedging in Forex market works in a similar way mentioned above, however, there's a variety of way to hedge in the Forex market for an investor as there are numerous options and future contracts available in the Forex market.

Although hedging may sound like a foul proof technique, there are still some reasons why an investor may need to think carefully before considering to hedge in Forex market. Firstly, hedging will be a very useful tool IF an investor suffers a loss in his investment due to the fact where by hedging, the amount of losses can be decreased and minimized to a smaller amount. However, hedging will only be a nuisance to the profit gain if the investor doesn't suffer any form of losses because the amount of potential profit would be greatly decreased due to hedging. Besides that, unlike buying insurance, hedging is not a 100% safe technique as hedging in Forex trading is not as simple as it seemed. Hedging precisely in an investment is a very complicated task and in most of the time, things may go wrong and not according to the way as planned.

For beginners in Forex trading, Forex hedging is always a very good tool to be utilized in order to avoid from suffering a huge amount of losses in their early stage of investment. Therefore, it is most advisable for all of the investors, regardless of what type of investment they are in, to understand more about hedging because this is considerably one of the most effective way in order to protect themselves in Forex trading.

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