What is hedging?
Hedging means opening a position that is expected to move against a position you already hold. If the original trade loses, the hedge is meant to gain, and the other way round. The aim is to reduce exposure, not to make money.
In forex, exposure is your sensitivity to a currency's price. A long position (a buy) gains when the price rises. A short position (a sell) gains when it falls. A hedge adds the opposite exposure, fully or partly.
Keep in mind that a hedge freezes a result. It does not repair it. If a position is already losing when you hedge it, that loss stays in the account. The hedge only limits how much further the combined position can move.
Leveraged forex and CFD trading can lose money fast. Hedging does not change that. It adds costs and decisions that can make results worse.
Direct hedge
A direct hedge is a long and a short position of the same size on the same instrument. For example, a long EUR/USD position and a short EUR/USD position of equal volume.
While both legs are open, price moves mostly cancel out. Each leg is a separate position, so the net result keeps changing slightly with spread, swap and commission.
Hypothetical example, for illustration only: a trader holds a long EUR/USD position that has moved into a loss. Ahead of a news release, the trader opens an equal short EUR/USD position. After the release the trader must still decide which leg to close and when. If the price recovers and the trader closes the short too late, the gain on the long leg is reduced by the loss on the short leg. The original loss was never removed. It was only paused, and costs kept running.
On a single account, a direct hedge gives almost the same exposure as closing the position. The difference is that both legs stay open and keep generating costs.
Correlated hedge
A correlated hedge uses a different instrument whose price has tended to move in line with, or against, the instrument you hold. Correlation is a statistical measure of how closely prices have moved together in the past.
Common hypothetical examples:
- A long EUR/USD position hedged with a long USD/CHF position, because these pairs have often moved in opposite directions.
- A long position in a currency pair hedged with a short position in a closely related pair.
The weakness is that correlation is measured on past data and can change or break down, especially around central bank decisions and major news. When that happens, both legs can lose at the same time. See Pairs trading for more on how correlation behaves.
Portfolio hedge
A portfolio hedge looks at total exposure across all open positions, not at a single trade. For example, a trader with several positions that all gain if the US dollar weakens has a large net short-dollar exposure. A position that gains if the dollar strengthens can reduce that overall exposure.
This requires knowing what each position actually depends on. Many pairs share a currency, so positions that look different can carry the same risk. Hedges at this level are usually partial, and the trader accepts that the offset will be imperfect.
What hedging costs
Each leg of a hedge is a full position with its own costs:
| Cost | How it applies to a hedge |
|---|---|
| Spread | Paid when each leg is opened, as for any position |
| Commission | Charged per leg on accounts that use commissions |
| Swap | Overnight financing is charged or credited on each leg separately; the combined result is often a net charge |
| Margin | Each open position may require margin; how hedged positions are treated depends on the broker's rules |
| Slippage | Closing legs at different times can mean worse prices, especially in fast markets |
Swap is the overnight financing charge or credit for holding a position past the daily rollover. The long and short swap rates on the same pair are usually not equal, so holding a direct hedge for days can steadily reduce the account balance. See Swap fees for how swap is calculated.
To see how much margin a set of positions may require at a given leverage, use the calculator below. Margin rules for hedged positions vary, so check the current conditions with your provider.
Fill in the empty fields to see the result.
Further tools are on the Calculators page.
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Specific ways a hedge loses money
- The loss is locked in. Hedging a losing position fixes the loss. It still has to be realised when the legs are closed.
- Legging out badly. Closing one leg and keeping the other turns the hedge back into a directional trade. If the price then moves against the remaining leg, the loss grows.
- Costs accumulate. Spread, commission and net swap on each leg reduce the balance even when price does not move.
- Correlation fails. In a correlated hedge, both legs can lose together.
- Price gaps. Over weekends or around news, prices can jump past planned exit levels on either leg.
- Stop-out still applies. Stop-out is the automatic closing of positions when margin level falls too low. A hedged account with little free margin can still be stopped out, possibly leaving one leg open.
- Avoiding decisions. Hedging can become a way to avoid admitting a trade was wrong. This links to Averaging down and Martingale strategy, where losses are carried instead of closed.
Typical rules traders use
These are general practices, not recommendations:
- Write down why the hedge is being opened and what it protects against.
- Size the hedge to the exposure being reduced, and know whether it is full or partial.
- Set exit conditions for each leg before opening, including which leg closes first.
- Estimate total costs, including swap for the expected holding time, before opening.
- Limit how long a hedge stays open.
- Compare the hedge with simply closing the position or using a stop-loss. Often the simpler option gives similar protection at lower cost.
Practise hedge mechanics on a demo account before using real money. See Forward testing and Trading plan. Broader principles are in Risk management.
Legal position in Pakistan
Before using any offshore platform, read the regulators' statements. Per the SBP, the purchase of offshore forex/margin/CFD products by Pakistani residents violates section 4(1) of FERA 1947, and per the SBP, remitting foreign exchange to overseas forex/margin/CFD platforms is not allowed through any payment channel (FERA s.5(1)). Per the SECP, offshore platforms have no Pakistani licence or oversight and offer no legal protection or recourse. More detail is on Law and regulators and Regulation and Safety.
Frequent questions
What is hedging in forex, in simple terms?
It is opening a position that offsets some or all of the exposure of another position, so that price moves affect the combined result less.
Does hedging remove a loss I already have?
No. The existing loss stays. A hedge only limits further movement while it is open, and it adds costs.
Is a hedge the same as a stop-loss?
No. A stop-loss closes the position and ends its costs. A hedge keeps the position open alongside an opposite one, so costs continue and you still have to decide how to close both legs.
Is a forex hedging strategy risk-free?
No. Hedges can lose through costs, poor timing when closing legs, correlation breakdown, price gaps and stop-out.
Do hedged positions need margin?
Usually each open position has margin requirements, but treatment of hedged positions differs between providers. Check the current conditions in your account area or on the provider's official site.
Where can I learn the terms used here?
See the Trading glossary and Trading basics.