A second trade to offset the first:hedging limits how bad is the worst.
Opening a position to offset potential losses in another position, reducing overall risk exposure.
In forex, hedging can involve taking an opposite position in the same pair or a correlated pair.
In plain words
Hedging means opening a second position whose result is expected to move the opposite way to one already held, so that a loss on one is partly or wholly offset by a gain on the other. It works like insurance: it reduces what can be lost, and it has a cost.
See it move
Position and Hedge are in balance
Why it matters
Traders and businesses hedge when they want to keep a position or a commitment but reduce their exposure to a price move for a time. A hedge also reduces the possible gain, and each position carries its own spread and possibly its own overnight charge.
Worked example
An example only. The figures are round and invented for the arithmetic: they are not market prices.
A trader is long one standard lot of EUR/USD and opens a short of half a lot on the same pair; the price then falls 40 pips.
- 1Long 1 lot40 × 10 = 400 US dollars lost
- 2Short 0.5 lot40 × 5 = 200 US dollars gained
- 3Net200 − 400 = −200 US dollars
The hedge halves the loss from the fall, and it would equally have halved the gain from a rise.
A common mistake
A hedge is sometimes thought to remove risk at no cost. A full hedge in the same instrument freezes the result where it stands while costs continue, and a hedge in a different instrument relies on a relationship that can change.
Check yourself
Educational information, not investment advice or a recommendation to trade.