What is Hedging?
Undoubtedly you have heard the term fall. But what exactly is meant by this? Let’s take a look at the encyclopedia:
Hedging – ‘Reducing risk by hedging financial transactions with opposite transactions’.
So that. ‘Hedging your trades’ means that you try to cover yourself against loss wherever possible. In other words, you are trying to find a way that will win you no matter what the market does. Even if it moves exactly the other way than you expected.
Gradations of Hedging
There are different levels of hedging and multiple possible tactics that you can apply to different forms of trading. To give you an idea of those gradations; think of covering what you are doing versus covering the trades yourself. A double touch option with a trigger point both above and below the current price is an example of a hedge where you give yourself the chance to win. Regardless of whether the price moves up or down. While you are just in one and the same trade. Or if you trade in Forex and you expect a breakout in a random direction, you could place an entry above and below the current price level and then remove the unnecessary entry as soon as the right one has been triggered. In that situation, you are also in one trade, but you have covered your bet.
Hedging Ideas for Binary Options Traders
Another way to cover your risk is to do two trades at the same time. Imagine that you trade in Forex. Then you could also choose to take two positions, and go for both a buy and sell. If you would opt for exactly the same bet, you have a net profit of zero (or better: a small loss due to the spread). That sounds indeed very absurd. But suppose you bet more on the direction you are most confident about, and a smaller amount in the opposite direction. If during the trade you are more confident that your instinct was correct, you can withdraw the last bet and go full before your first choice. If it does not go exactly as you thought, but you leave both options standing, you will at least get something back from the smaller bet.
With binary options, you generally can not take two conflicting positions in a single trade for a single asset. You have to choose one direction, high or low. The hedge tactics that you could apply here is to open trade for a related asset – which you expect to perform more or less the same – and take the opposite position.
There are also traders who choose to trade Forex in both binary options. This provides another hedging option. For example, suppose you choose ‘high’ for a binary option for a particular currency pair, but you want to hedge and also place a smaller ‘low’ bet. If you are also a Forex trader, you can choose a smaller bearish position on your Forex platform, while at the same time you have your bullish binary options trade. If your binary options trade is unsuccessful, you still have your loss covered.
Examples of Hedging
If you opt for hedging, there are several possible outcomes, depending on how you distribute your money. Put simply: if you opt for the same bet for both positions, then you play basically even (minus the fees you have lost). If you opt for a higher bet in either position, you have to have significantly more confidence in that position. It could mean that you lose in a different position. The last thing you want is that the position with the lower bet wins, and the position with the higher bet loses.
If you have both a binary options account and a Forex account, you can also use the binary option as a hedge for your Forex bet. In other words, instead of using your binary option as the most important trade and your Forex trade as ‘insurance’ against any loss, you use the binary options trade as the ‘insurance’ and your Forex trade is the important trade. This would be a smart choice if no rollover for winning trades is offered. Why? Your binary options trade is limited, so if it becomes a loss, the loss is limited. With Forex, on the other hand, you can stay in the trade as long as you like, if you are on profit. So you have the chance of unlimited profits while at the same time limiting your losses.
Analyze your risk beforehand.
If you decide to enter a trade, first check how much money you risk at all if you do not opt for hedging.
Decide whether you consider that risk acceptable or not.
For how many would you have to cover to make the risk acceptable? Remember at all times that you can never fully cover.
First, think of an appropriate strategy for the trade you want to do.
In short, the first test whether your hedging tactic is valid. If you as a trader are planning something new, always make sure that you first find out through backtesting and demo testing whether your tactics can actually work and is potentially profitable. So first check if it is correct on paper before you apply it live. You change your money management plan, one of the three pillars on which your success in action depends, next to discipline and a trading system.
Analyze the results.
Make sure you note your trading results somewhere. In this way, you not only know whether your hedging tactics also produce the desired results. You can also look more easily at what you need to adjust if it does not work out as you intended. If you encounter problems (read: lose), go back to the drawing board and test until these problems are resolved. And if you feel that you can improve things, test this first. If you act, this means that you have to be continually sharp and always have to refine or improve your trading method in order to remain successful.
Hedging can be an extremely valuable strategy if you trade in binary options. There are several creative ways in which you can limit your risk and maximize your profits. If you have never done hedging before, do online research on hedging strategies first. Then grab your charts and test whether the strategies work. In addition, hedging, in general, should be something for you. Some traders find that hedging only makes the entire trading process unnecessarily complicated. But for risk-averse traders, hedging can ensure that trading in binary options becomes more accessible. When you hedge against possible risks, you not only build a buffer against financial losses. It is also a psychological buffer that can take away the uncertainties associated with the action. And give you exactly the confidence that you need to become successful.