Hedging is one of the smartest yet trickiest strategy 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)
|Looking for advanced Hedging Forex Brokers Comparison? Try our Forex Broker Comparison|
Starting form 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 an 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.
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 effect 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 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.