Brokers that allow hedging in a trading account give traders the flexibility to buy and sell simultaneously. In some jurisdictions (regions) around the world, hedging as a strategy is forbidden by the regulators. Hence, not all Forex brokers in the world give traders the possibility to hedge. The FX market is often used as a tool itself to actually hedge an investors portfolio.
Top Forex Brokers that allow for Hedging
Hedging is one of the smartest yet trickiest strategies to apply in Forex trading.
Hedging frees you from dependency on the market direction because with hedging you are trading both ways (up and down, or buy and sell).
All Forex brokers nowadays allow and support hedging, except for US-based brokers (about which you can read below). The most convenient type of platform for hedging is the one that supports OCO orders (order cancels order). Unfortunately, the popular MT4 platform doesn’t have OCO orders, however, MT5 platform does. With MT4 however, hedging can be simplified with the use of an Expert advisor.
(Example of MT4 hedging EA that uses grid trading: download MT4 hedging EA)
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Starting from May 15, 2009 new NFA (National futures Association) Rule 2-43(b) will completely ban the use of hedging for traders who trade with US brokerage firms regulated by NFA.
This New Compliance Rule 2-43(b) requires an FDM (Forex Dealer Members) to offset positions in a customer account on a first-in, first-out basis, thereby prohibiting a trading practice commonly referred to as “hedging.”
What Is Hedging?
Hedging is a strategy used to minimize the risk of a reverse price movement against one or several of your open positions. For example, a trader who has a large trading position – Long 50 lots EURUSD, might decide to hedge a portion of his position by shorting 30 lots of the EURUSD. Now, in the case of an adverse or volatile price movement, a portion of the loss on the long side will be offset by the gain on the short.
However, per the new NFA rule, a trader will no longer be able to hedge a position. Instead of simultaneously holding both positions, he will now need to close out those 30 lots. Thus, rather than being long 50 lots EURUSD and short 30 lots EURUSD, he will now be simply long 20 remaining lots.
What Is a Hedging Account?
A hedging account is a regular Forex trading account where one can sell or buy the same currency pair simultaneously. A fully hedged account is when the volume traded on the long side equals the one traded on the short side on the same currency pair.
If that’s the case, then the trader only pays the negative swap (if any) at the end of the trading day.
Partial hedging refers to the situation when the volume traded on the same currency pair is different. For example, one may trade one lot EURUSD on the long side and half a lot on the short side. That’s partial hedging, as the market exposure is the difference in the two trades’ volume.
Hedging is seen as a safety net for many Forex traders. Should the market move against them, the impact on the trading account will be less severe than if they had held the position un-hedged. Another important thing to consider is that many Metatrader EAs are programmed to use hedging to offset risk. If you are using one of these trading robots it is very possible that the hedging ban will drastically increase the risk of your EA. For those who bought EAs, it would be wise to contact your EA vendor to find out if any type of hedging is used, and how this ban will affect the EA…
Another reason why hedging can be beneficial is due to the extreme volatility that can often be found in certain trading periods. Specifically, when when the market first opens on Sunday evening or during news announcements, prices can spike drastically in either direction. It can be difficult to get out of a trade as the spreads tend to widen out. By placing a hedge before these volatile times, you may reduce the effect of volatility since you have a position in both directions. This can be beneficial because it allows you to keep your positions open without the fear of being stopped out.
How Can You Use a Hedging Account?
For instance, if you sell short the EURUSD and go long EURUSD at the same time.
Why would anyone do such a thing? It depends on the trading strategy.
Traders look at all timeframes for possible trades, and the time needed for a trade to conclude differs. If the trade comes from the bigger timeframes, it takes longer to reach the take profit.
However, in the meantime, a different opportunity may arise on a lower timeframe. Only this time, in the opposite direction. You can trade both trades using a hedging account.
Pros and Cons of a Hedging Account
- Take advantage of all the opportunities provided by the market
- Gain free margin available instantly for other trades
- Protect the trading account from unexpected market moves
- Considered a risky strategy
- Forbidden in certain parts of the world
- Requires strict money management rules and trading discipline
Factors to Consider When Choosing a Broker for a Hedging Account
Typically brokers operating in the United States can’t offer hedging accounts. If that’s the case, FIFO (First In First Out) limitations exist too.
If a broker does allow hedging, the FIFO rule does not apply. It means that there is no closing order for the opening trades, traders having the liberty of using any strategy they want.
A hedging account doesn’t limit the potential of any strategy. Imposing limitations have the effect of driving traders away from brokers that do that.
However, some traders prefer avoiding hedging whatsoever. The psychological pressure of dealing with both a short and a long position is overwhelming. Moreover, for some people, hedging doesn’t make sense at all.
But hedging is a very powerful risk management strategy. When used correctly, it brings tremendous benefits to the trading account.
Do I pay commissions and fees on all trades part of a hedge?
Yes. Any individual trade is subject to commissions and fees, regardless of the reason behind its opening.
When fully hedging a trade, is there any margin still blocked?
Yes. The broker still requires some margin as collateral, albeit a not so much as prior to the hedge.
After hedging a position, can I close any one of the trades that are part of a hedge?
Yes. A brokerage house that allows hedging doesn’t have limitations as to what trade to close and when. Simply choose the market direction you want to have an exposure after giving up the hedge and trade accordingly.
Is the FIFO rule imposed on a hedging account?
No. If a broker allows hedging, there’s no FIFO rule to obey.
How to Get Around this Hedging Ban
To continue hedging with NFA regulated brokers, a trader now needs to open 2 accounts with the same one or different brokers. Then he will simple Short a currency pair on one account and Long it on another account hence getting the same hedging effect. The only trouble this time would be: you’ll need to put some more net capital into two new accounts, or at the very least to be prepared to swiftly transfer cash on a regular basis from an account that is showing a healthy profit to one where the trade is experiencing a significant drawdown.
For traders who are dependent on EAs that use hedging heavily and do not want to change trading tactics, there is also an option to consider a broker, who is not regulated with NFA, or simply a broker outside US.