What is Hedging?
February 8, 2018 Print
Even if you are not a trader you would have most probably heard or used the term, “hedging your bets.” The phrase is used in day to day life. When you see somebody equivocating on some point, and trying to cover all his bases, we say, “That person is just hedging their bets.” It means exactly the same when used in trading. It basically means that you are trying to cover all your bases and ultimately protect yourself against losses in the best way that you can. When you hedge, you generally are trying to find a way to make a profit no matter what the market does, even if it ends up doing the exact opposite of what you thought it would do.
Hedging Ideas for Binary Options Traders
There are numerous degrees of hedging, and there are different tactics that you can use to hedge in different types of trading. For an example think about hedging your trade entries versus actually hedging your trades. A Double Touch option with a trigger point set above and below the current price would be an example of a hedge where you are giving yourself the possibility to have a successful trade whether the market goes up or down, but you are in only one trade. If you were trading Forex, expecting a breakout in either direction, you could set an entry above or below the current price level, and then simply get rid of the other entry once the correct one triggers. In that situation, you are also only in a single trade, but you still hedged your initial trade at the point of entry.
Another more common way you can hedge is by actually being in two trades at the same time. If you were trading Forex, you could for example open two opposing positions from a single entry point, a buy and a sell. If the two positions are the same size, while both are open, you have a net profit of zero (a small loss actually, from the spread). This may sound useless, but consider that you could make a larger trade in the direction you have more confidence in, and a smaller trade the opposite way. As your confidence grows during the trade, you could close the smaller position. But if things go badly and both positions are still open, the smaller profiting position would at least return some of your money and so reducing your trading loss.
In general, with binary options, you cannot open two conflicting positions on a single asset for a single trade. You have to pick a direction, High or Low. You could however hedge by opening a second position in the opposite direction on a related asset which you expect to behave more or less the same way as the.
Some traders also may decide to trade both binary options and Forex. This gives you yet another hedging possibility. Say for example that you choose “High” on a binary option for a particular currency pair, but you want to hedge and open a smaller bearish position. If you are also a Forex trader, you could open a smaller bearish position on your Forex platform at the same time you enter into your bullish binary options trade. This gives you some degree of protection should your binary options trade go against you.
Whenever you hedge, there are a number of possible outcomes, depending on how you manage your money. By default, if both positions are the same size and both are open, you are breaking. If you size one position larger than the other, you have to make sure you are significantly more confident in that position, because the smaller one will be taking a loss. The last thing you want is for it to be the smaller one that is winning and the larger one that is losing. If you have a binary options account as well as a Forex account, another thing you can do is use the binary option as a hedge against your Forex bet. In other words, instead of making your binary option your primary trade and your Forex trade your “insurance” against a loss, you can make the binary option your “insurance,” and your Forex trade your main trade. This would be a good move if there is no rollover for winning trades offered by your broker. Why? Your binary options trade is limited, so if it becomes a loss, it is a limited loss. But with Forex, you can continue to stay in your trade as long as you want if it is winning, so you give yourself the possibility of larger gains, while controlling your losses. Once that Forex trade is winning, you can move that stop to breakeven.
Hedging can be a powerful strategy for trading binary options. There are numerous creative ways you can reduce the risk of your trades and maximize your profits. If you are new to hedging, look up different hedging ideas online, open up your charts, and start testing the strategies you find. For some new traders hedging only complicates trading, but for the risk averse, hedging can make trading more accessible. Reducing your exposure to risk can not only buffer your account against monetary losses, but can also buffer your psychology and help you to cope with the uncertainties of trading.
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Article source: Markets World Blog