Overview
Hedging describes a situation where multiple positions, either with the same or different instruments are used to offset potential losses. For example, a perfect hedge would be to simultaneously create identical buy and sell positions of the same currency pair. Although there is no room for profit, there is also virtually no chance of a loss while both positions remain active.
Hedging is more commonly used to create multiple positions that will limit losses, but as you may have guessed, will also result in smaller gains. When setup correctly, hedging has the ability to bring consistent smaller wins, rather than the risk of inheriting large losses.
What Can I Hedge?
Using the RetroForex trading platform there are virtually endless hedging strategies by combining spot and option positions. For example, you could create a one touch option, with a simultaneous spot position having a stop loss equal to the option target and a take profit set far enough to compensate the purchase of the option. This is actually the topic of the next section – automatic hedging.
Automatic Hedging
RetroForex includes a unique auto-hedging feature that simultaneously creates a one touch option with a spot position. The strategy functions by:
- Setting the spot stop loss equal to the option target.
- Calculating the necessary pip value based on the user desired percent hedge.
- Setting the spot take profit at a distance so that when triggered will create a profit greater than the purchase price of the option (premium).
This type of hedge creates a combined position where there is a probability for one of several outcomes:
- Option Wins, Spot Loses = Total Position is Profitable.
- Option Loses, Spot Wins = Total Position is Profitable.
- Option Wins, Spot Wins = Total Position is Profitable.
- Option Loses, Spot Loses = Total Position is Unprofitable.
When a hedged position is created correctly there is a mathematically greater chance that the combined hedged position will become profitable.