There’s two diverse opinions on the subject of multiple currency pair trading, do or don’t, yes or no. The principal use and major benefit for engaging in a multi pair trading strategy is to hedge the overall risk, this can be done by observing the currency pair correlations that exist in the market place at any given time. Many experienced traders suggest that hedging and or correlation trading should only be used on swing and or position trading strategies. If traders take the time to analyse the charts of the four main trading pairs and the three commodity pairs the correlations and the reaction to the main moves in the market can be clearly seen.
Certain brokers such as FXCC allow traders to place trades that are direct hedges. Direct hedging is when traders are permitted to place trades buying a currency pair and at the same time selling the same pair. Whilst theoretically at conception the net profit is zero when opening both trades immediately, traders can make more money without incurring additional risk if their market timing is right.
Hedging is by definition a method of devising a strategy in order to protect versus big losses. Hedging could be considered as an insurance policy versus individual or collective trades. If employed correctly hedging permits traders to reduce their losses particularly with regards to unexpected events taking place.
Simple Hedging Technique
A simple forex hedge method is one that encourages trading in the opposite direction of the initial trade without having to close that initial trade. Whilst an argument could be put forward that it makes more sense to close the initial trade for a loss and place a new trade at a better price, this is at the heart the reason why a trader would use hedging as part of their trader discretion.
Traders could close the initial trade and enter the market at a better price. The advantage of using a hedge technique is that traders can keep their trade live in the market and bank additional profit with the second antagonistic trade which banks additional profit as the market moves against the first position. When suspecting that the market is going to reverse back to the initial trade’s direction, traders can set a stop on the hedging trade, or simply close it.
Multiple Currency Pairs Hedging Technique
Experienced forex traders often take hedge trades versus a particular currency by using two different currency pairs. For example, you could go long on the EUR/USD pair and short the USD/CHF pair. In this instance and it’s not an ‘exact science’ technically traders would be hedging their USD exposure by pairing the USD versus the volatility of both the euro and Swiss franc.
The major contentious issue with hedging in this manner is that traders are exposed to both fluctuations in the Euro(EUR) and the Swiss(CHF). If the Euro suddenly develops market strength and becomes a strong currency versus all its peer currencies, there could be a fluctuation in EUR/USD that is not immediately counter acted in USD/CHF. This is generally not a reliable way to hedge unless you are building and operating a complicated hedge strategy that takes many currency pairs into account. This type of multi pair hedge/correlation strategy can take many years of experience to perfect, particularly if the trader trades the four majors and three commodity pairs concurrently.
Using Forex Options
A forex option is an agreement to conduct an exchange at a specified price some time in the future. As an example let’s suppose a trader places a long trade on the EUR/USD pair at 1.30. In order to protect that position the trader places a forex ‘strike option’ at 1.29. If the EUR/USD falls to 1.29 within the time specified for your option, the trader gets paid out and banks the profit on that option. How much the trader banks will depend on market conditions when you buy the option and the size of the option. If the EUR/USD does not reach that price in the specified time the trader loses only the purchase price of that option. The bigger the distance from the market price the option at the time of purchase is, the larger the profit will be if the price is hit during the specified time.
Reasons to Hedge
The main reasons to hedge is that traders want to use hedging to limit overall risk. Hedging can become a significant part of a trader’s trading plan. However, hedging should only be employed by experienced traders who understand market swings, positions and crucially market timing. Practising hedging techniques by even the most experience traders can be challenging, without adequate trading experience it could be prove to be a disaster.
Those new to hedging techniques would be best advised to monitor all four major pairs and the three commodity pairs on a swing strategy over a period of several months before engaging with the market. In doing so the trader will be able to clearly see the reaction between the main indice markets, the currency markets and the correlations between the seven pairs overall. Armed with this information and evidence the trader would then be ready to employ a hedge strategy with confidence.