How to hedge risk when trading forex?
Forex is a massive step from trading other financial instruments, such as stocks and futures.
Forex trades deal in much higher volumes and at prices that can fluctuate by several percentage points within a single day (or even an hour).
Therefore it takes an increased amount of skill and knowledge to make forex work for you versus simply buying/selling other types of securities.
One key difference between forex and the instruments mentioned above is the lack of transaction fees on most forex trades.
It can become problematic because, without transaction fees, there’s no way to penalise traders for placing wrong orders.
There’s also nothing to reward them when they place good orders, either.
There are two primary forms of deciding which currency pairs will move: fundamental analysis and technical analysis.
Fundamental analysis is based on current events, GDP growth of a country, unemployment numbers, new products or services developed by the government and more.
These things affect what happens in the economy and how people use currencies to invest and spend money.
Technical analysis focuses on price action over time. Price charts are studied for specific patterns that can predict future price movement.
For a highly detailed look at this topic, I would recommend taking some time to study up statistics such as Bollinger Bands (which show the volatility of price) and candlestick formations like hammer/shooting star signals.
One significant risk associated with forex trading is counterparty risk. When you place an order with a broker, that broker is obligated to fill your order at the price you want.
However, there’s no guarantee that they will be able to fulfil their obligation. It means that they may not have enough liquidity in the market to execute your trade.
If this becomes a severe problem for brokers, it can lead to them “ramping” their spreads (selling high/buying low) until they are profitable again or regulators force them to stop trading.
One way traders choose to reduce counterparty risk is through hedging. Hedging is just a fancy term for taking an opposite position in another market so that if one of your trades goes well, the other side of the trade doesn’t work to lose out on any potential gains.
Margin trading comes with the inherent danger of too much exposure to market fluctuations.
After all, more significant investment amounts are naturally more risky than smaller ones because they have a more significant impact on relative price movements.
Stretching yourself too thin by overextending your available balance means you will be forced out at unfavourable price levels when they inevitably occur.
It can lead to significant losses over time, especially if the trader has a prominent open position.
To hedge your risk, you need a trading strategy. Several different strategies can be adapted to manage the inherent dangers of margin trading properly.
The one that cancels other orders is an advanced retail forex trading order type where pending orders for opposite directions will be cancelled if only one gets executed.
It happens on signals generated by technical analysis tools like candlesticks, moving averages, and price action reversals around support and resistance levels.
It is beneficial to catch a short-term spike on the higher timeframe while also protecting against unwanted entry into a longer-term trend on lower time frames that could produce losses after the signal has lost momentum.
The best way to minimise risk is to ensure you are trading with an account size appropriate for your line of work. You can begin with a small sum since most brokers offer demo accounts with no initial deposit required.
However, if you’re serious about trading as a career, it’s always advisable to move up in stakes as quickly as possible.
You want to buy a currency pair with a possible increase in volatility after a long period of low activity.
You also want to make sure you exit the trade if it turns out to be a longer-term trend, so you cancel other orders for both buying and selling just below or just above your expected trading range.
If the price breaks out past the top entry point in either direction, only one order will execute while the other is automatically cancelled. It allows you to avoid profitable closing positions prematurely due to early signals from lower timeframes.