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Trading forex online, forex trading strategies Hedging your position with different pairs Hedging has been popular with traders over the years, sometimes with good reason, at other times on shaky grounds. Trading forex online is mostly something you teach yourself, and as you do so, you learn that it is all about controlling your risk. Hedging is one of the ways of controlling risk, and it is perhaps most efficient when used in conjunction with a carry trade strategy. When hedging one trade in a currency pair with another in a different pair, you’re essentially aiming to reduce your risk by making use of the inverse correlation between the two.
If one pair usually responds to movements in another pair with movements of a comparable size in the other direction, we say that there’s a strong inverse correlation between the pairs. In this case, if we buy one lot of the pair X, and one lot of the pair Y, the result would be similar to holding a smaller position of the X pair, because of the inverse correlation between the pairs in question. Now what is the point of hedging if all you’re doing is reducing the size of your position? You can simply buy a smaller quantity of pair X and forget about hedging altogether. At this point we must consider the impact of the interest rate.
Let’s say that pair X is paying 5 percent interest, has an inverse correlation of 0.8 with pair Z (which is rather high) which is paying 0.2 percent interest. In this case, in a carry trade strategy, we can reduce the volatility of our portfolio significantly by buying 1 lot of X, selling one lot of Y, while at the same time receiving approximately (5-0.2) in interest. We can never achieve this kind of leverage in interest income merely by buying the X pair, of course, but by combining these two, we can reduce volatility, increase the lifetime of our trade, and at the same time continue to receive maximum income from the interest paid.
The correlation between different pairs is available at the websites of some brokers, and also at reputable forex websites. The carry trade is of course one of the most successful and proven forex trading strategies in the trading world. When combined with this hedging approach it can be exceptionally profitable with a much smaller risk, and that is why it is popular among trader. Just use a sensible approach to make sure that you don’t trade with more than you should, and the benefits of hedging in combination with a carry trade strategy will ensure that your account is soon much more profitable than it was before.
If one pair usually responds to movements in another pair with movements of a comparable size in the other direction, we say that there’s a strong inverse correlation between the pairs. In this case, if we buy one lot of the pair X, and one lot of the pair Y, the result would be similar to holding a smaller position of the X pair, because of the inverse correlation between the pairs in question. Now what is the point of hedging if all you’re doing is reducing the size of your position? You can simply buy a smaller quantity of pair X and forget about hedging altogether. At this point we must consider the impact of the interest rate.
Let’s say that pair X is paying 5 percent interest, has an inverse correlation of 0.8 with pair Z (which is rather high) which is paying 0.2 percent interest. In this case, in a carry trade strategy, we can reduce the volatility of our portfolio significantly by buying 1 lot of X, selling one lot of Y, while at the same time receiving approximately (5-0.2) in interest. We can never achieve this kind of leverage in interest income merely by buying the X pair, of course, but by combining these two, we can reduce volatility, increase the lifetime of our trade, and at the same time continue to receive maximum income from the interest paid.
The correlation between different pairs is available at the websites of some brokers, and also at reputable forex websites. The carry trade is of course one of the most successful and proven forex trading strategies in the trading world. When combined with this hedging approach it can be exceptionally profitable with a much smaller risk, and that is why it is popular among trader. Just use a sensible approach to make sure that you don’t trade with more than you should, and the benefits of hedging in combination with a carry trade strategy will ensure that your account is soon much more profitable than it was before.
