Risk insurance: who is a hedger and who is a speculator

Master Class: The Stock Exchange for Beginners. Lesson 18

Protecting oneself from risks is a reasonable approach of homo sapiens, and in the market and when working with money this measure becomes forced and necessary, because reducing risk and saving money here is one of the ways to keep the deposit and its growth.

Hedging (from English hedge, "hedge", "protect") as a way to avoid risks in trading, both stock and currency, is widespread. The notion itself has the following content: a set of similar, single-type instruments used in the market is used to reduce the risk level, in order to minimize possible losses on positions. At the same time, the reduction of losses is placed above the possible growth of the deposit.

Hedging your tradesWhether it is the stock market or the currency market, the trader influences the market demand, as well as the balance of power of buyers and sellers - to a greater extent, large strategic or institutional investors, than traders with small deposits, can notice it.

In order to hedging to apply most effectivelyIn order to make a decision, it is necessary to carefully monitor the market situation, first of all, as well as to monitor exchange rate forecasts and analytics provided by analysts and investment houses. On the basis of the totality of information events you can make decisions.

Forex Hedging

At foreign exchange market Hedging is mainly used as a method of insurance by placing an additional position on a third-party, less volatile instrument, although in some cases it may also attract profits. In this case, hedging can take place both in the form of mutual settlements and in the format of non-correlated trading instruments.

There are many ways to hedge positions on :

– the trader, hedging his position, opens another one in the opposite direction to the currency pairThe currency pairs EURUSD, GBPUSD, NZDUSD and AUDUSD are examples. Examples are the currency pairs EURUSD and GBPUSD, NZDUSD and AUDUSD.

– the trader, hedging the risks, opens two positions in one direction (only to buy or only to sell) with currency pairs that have a high negative correlation, and the exhibited volume will be the same. As an example let's take EURUSD and USDJPY or GBPUSD and USDJPY.

- if a trader needs to hedge a transaction that is open for a long-term perspective (a year or more), and a suitable liquidity, volatility and correlation of the hedging instrument is not, often use roll-over method or roll-over method. In this case, the hedging position, equal in volume to the main transaction, is opened for a partial period, such as 3 months. It is closed when the market characteristics of the hedging asset begin to diverge from the main, after which the investor again seeks a suitable short-term insurance transaction, and so on. "Rollover" is called this approach because it takes place in several stages.

Interestingly, in the case where the trader's goal is solely to avoid risk in the application of hedging, it is called hedge; if the trader has plans to benefit materially from hedging, it is called speculator. In this case, the latter takes risks consciously and tries to get the most out of the game on the differences.

Other methods of hedging transactions in Forex?

Positions are hedged not only with similar currency pairs, you can do it with precious metals (gold, silver, platinum), commodities and currencies futures (oil, gas), indices

differences in the timing of placing hedges, differences in lots, structural differences in the movement of currency pairs (volatility exposure, etc.).

It is necessary to distinguish such aspects of hedging as risk avoidance on the buyer's side or hedging on the seller's side, which is more typical for the stock market, in which it matters whether a profitable or unprofitable position is hedged.

Pros and cons of hedging

However, do not make the mistake of thinking that hedging has only obvious pluses. The disadvantages of this approach to risk avoidance include additional losses (higher margin requirements, higher commissions, swaps), and solid time and money expenditures.

Among the positive aspects of hedging - reducing the risk of the transaction, avoiding the excessive influence of the external background, solving a number of problems to reduce all kinds of financial risks.