Hedging in the stock industry is a method of reducing risk by opening opposing positions against each other. So what is Hedging strategy? How to trade effectively with Hedging? Let’s explore details with Learn Forex Trading through the article below!
Concept of what is Hedging?
Hedging is also known as price hedging. This is a technique to minimize risk in the investment field. The purpose is to protect the portfolio from unwanted price fluctuations.
Technically, to perform price hedging, investors need to open a position opposite to the current position in a certain asset. In a situation where the asset price changes in the opposite direction than expected. Defensive positions will bring profits. This profit will help compensate for the loss from the original position.
In the stock market, futures contracts are derivative products. It allows investors to short-sell and profit when the market falls. When the market experiences a bearish period, futures contracts can be profitable. Thereby, losses from the investment portfolio can be reduced. However, in US, the derivatives market currently only offers two basic types of products. One is the VN30 index futures contract and government bond futures contract. Among them, futures contracts with the VN30 index are more popular. As for government bond futures contracts, they are rarely traded. It is often caused by institutions trading among themselves.
The decision to perform Hedging operations and the level of risk protection depends on the specific investment strategy of each investor.
See more: What is a trader that becomes successful?
Meaning of what is Hedging?
Hedging is seen as a tool that acts as a barrier. It helps protect and prevent risks during the investment process. So what is the important meaning of what is Hedging? The following are aspects of its meaning:
- Stabilizing cash flow: Hedging plays an important role in maintaining the stability of cash flow.
- Determining the selling or purchasing price of goods or security: Hedging not only assists in determining the selling or purchasing price of the goods but also dazzles in implementing security measures.
- Reduce potential risks: One of the important functions of Hedging is to minimize potential risks from unexpected market fluctuations.
- Reduce trading costs: Hedging can reduce trading costs by streamlining the risk management process. From there, investment strategies can be optimized.
What are the common forex hedging tools?
In reality, different Hedging media carry distinct characteristics. It is designed to reflect suitability for each specific condition and type of market.
After understanding the meaning of what is Hedging, investors need to know its common tools to be able to take advantage of it effectively when trading.
Forex market
The currency market is large in scale, attracting the participation of individuals and businesses. Also with institutional investors. In US, foreign exchange trading activities are often mainly about buying foreign currency. Aims to make payments for international import orders.
In this process, hedging measures are often applied through the use of forward contracts due to their flexibility in exchange rates and maturity times. Businesses can freely negotiate directly with banks on foreign currency trading conditions. To ensure that they accurately reflect the actual business situation.
Stock market
The two most popular instruments in the stock market are usually futures contracts and options. The unique nature of this market is the ability to exchange assets continuously and quickly. That leads to price fluctuations that are difficult to predict in a short time. This is the time when options tools can best promote their advantages.
Commodity market
The most popular instrument in the commodity market is futures contracts. These market participants are required to consume or use the goods. However, it is susceptible to fluctuations due to factors such as weather, raw materials, environment, etc. Therefore, futures contracts appear to ensure that transactions will be performed at the expected price in the future. future.
Commodity futures contracts often have clear terms. Including form, quantity, quality, as well as maturity and value. For that reason, it is the right tool to ensure that the transaction will take place most conveniently. Especially even for items of diverse and complex nature.
What is an effective strategy when trading with what is Hedging?
Hedging is often widely applied in stock trading, commodity derivatives, and foreign exchange markets. So how to trade effectively with what is Hedging? The following are trading strategies with Hedging:
How to apply hedging forex properly
In the field of stock trading, Hedging is often widely applied. It is applied through the use of options and futures contracts.
For example, suppose an investor owns 2,000 shares of A stock at 60,000 USD/share. They want to minimize the risk of market volatility and stock prices falling.
The investor decides to buy a put option for 2,000 shares A with an exercise price of 55,000 USD/share, including a fee of 3 USD/share. When the maturity date comes, there are two scenarios:
- The stock price decreased as expected, to only 40 USD/share. The investor exercises the sell option, reducing the loss from 20,000 USD/share to 8 USD/share.
- The price of stock A did not decrease but increased to 65 USD/share. In this case, the investor does not use Hedging and decides to sell shares to take profits in the usual way.
However, in reality, the Hedging technique has more complex aspects. However, it helps limit the risk of loss to the best level.
Hedging method in commodity markets
The commodity market trades a variety of products. Including agricultural products, metals, minerals, and energy. These types of goods often experience strong price fluctuations due to the influence of many factors. Including natural disasters, weather, government regulatory policies, and market demand. Therefore, Hedging is a popular strategy for hedging risks in the commodity market. Hedging helps minimize losses that may arise due to price fluctuations.
For example, suppose a company plans to import 1,000 tons of raw rubber for use in the manufacturing process. However, there is a possibility that in the next 6 months, rubber tree productivity will decrease. Leading to an increase in raw rubber prices on the world market. To deal with this situation, the company decided to use hedging by using futures contracts to order a specific amount of raw rubber at a previously agreed price. When the due date arrives, if the company needs to import 1,000 tons of raw rubber, two cases can happen:
- If the price and fee for importing rubber through futures contracts are equal to or higher than the spot price. Meaning the market did not increase in price as expected. This will cause a large cost loss to the company for this shipment.
- In case the price and fee of the futures contract are lower than the spot price of rubber. That is a sign that the company has implemented Hedging effectively.
Hedging forex in the foreign exchange market
The foreign exchange market is where currency pairs are traded and bought/sold. Hedging plays an important role in helping investors and businesses minimize losses that may arise due to exchange rate fluctuations.
In the forex market, hedging can be done in the following three ways:
- Direct Hedging: The trader opens a long position and a short position for the same currency pair at the same time.
- Hedging multiple currencies at the same time: Traders open long or short positions in currency pairs that are closely related to each other.
- Hedging through options contracts: Traders buy or sell options contracts to protect themselves from exchange rate fluctuations.
Hedging is a useful tool that helps investors in the foreign exchange market minimize risks. However, Hedging also carries its own risks. Before using it, investors and businesses need to learn carefully about types of Hedging. This is to ensure the effectiveness of the strategy.
Along with learning forex hedging, traders need to learn about the Bull trap. From there, you can avoid bull trap risks and increase your trading profits.
See more: Opening and verifying an ICMarkets account
Some notes when using What is Hedging?
Hedging forex is an extremely effective risk prevention strategy. However, it is not an investment tool. So what should you note when using what is Hedging? To use Hedging effectively, investors need to consider the following points:
- Increased costs: Implementing Hedging often requires traders to pay fees for Hedging contracts.
- Prioritize hedging protection by opening a low-volatility position: Opening a hedging position with a highly volatile asset can increase investor risk.
- The forex market is always difficult to predict: Hedging cannot completely guarantee to prevent losses for investors. Because the market is always unpredictable.
Not all exchanges accept Hedging: In the US forex market, only a few exchanges accept Hedging. Including futures contracts for the VN30 index and government bonds.
Besides, learning about the what is Scalp strategy can help users build more effective trading plans. From there you can optimize your profits on forex.
Conclude
Based on the information shared in the article, Learn Forex Trading hopes that you have more knowledge about the concept of what is Hedging and how to apply this method effectively in stock market transactions, commodity markets, and foreign exchange markets.
Frequently asked questions
What are the popular hedging methods?
Hedging can be done through futures and options contracts. There are also opposing position-opening strategies to reduce risk.
Is hedging available to individual investors?
Yes, individual investors can use the tools. Includes options, ETFs (Exchange Traded Funds), or futures contracts for hedging.
How to ensure effective hedging?
To be effective, investors need to clearly understand their risks. From there you can choose the appropriate Hedging method. It is necessary to monitor the market to adjust strategies when necessary.
