What is Hedging?
Hedging is a method, which is used to reduce the possible harm of an adverse event.
Traders and corporations use hedging techniques to reduce their exposure to various risks.
Technically, hedging can be made for one investment to hedge another by strategically using instruments in the market.
The hedging trading strategy is allowed by many online Forex and CFD brokers with “Hedging Account”.
In case a broker offers only “Netting Account” option, then performing hedging trading strategy is not possible as all positions on the same financial instrument will be consolidated into one order.
Example of Hedging Trading
For example, a petrol company is worried about the volatility in the price of oil, as it is the primary raw material.
To protect (hedge) itself against the price growth, the company can enter a long-term trade contract and buy the oil at a specific price and date.
There are two possible outcomes:
- The price of the oil may grow above the contract price, and the company will save money by paying less because of hedging.
- The price of the oil may decrease, and the company will be obligated to pay more according to the predetermined contract price that will be higher.
However, thanks to hedging, the company secured the possibility of planning its budget based on the already determined price.
Therefore, hedging, for the most part, is a technique by which a trader can reduce potential loss.
Larger leg rule on Hedged positions
For some brokers, margin calculation for hedged positions is following a calculation based on the “larger leg”.
This means that the margin required for hedged positions will be the one of the larger side of the hedged pair.
- Buy 2 Lots / Sell 2 Lots of the same pair: Margin Required will be for 2 lots.
- Buy 2 lots / Sell 5 lots of the same pair: Margin Required will be for 5 lots (being the larger leg of the hedged pair).
You should be able to have multiple positions on the same symbol with this type of broker, but the margin requirement won’t be offsetting.