Why I Hate Forex Hedging

You may ask why I entitled this article I Hate Forex Hedging. It refers to retail forex hedging, a term manufactured by forex brokers to create more volume. Some retail forex traders may argue otherwise but I see it benefiting the broker and not the trader. All it does is create two offsetting positions in the same currency (i.e. one long, one short in like amounts), which is the same as being flat but giving the appearance of having two independent positions on.

What is forex hedging?

When I started trading, the term fx hedge referred to crossing an existing position in one currency with another position in another currency in an equal dollar amount. This led to a shift in risk from a dollar exposure to one involving a cross. For example, if you are long $3 mln USDCHF (i.e. short CHF) and want to hedge your dollar exposure, you might buy $3 mln worth of GBPUSD (i.e. long GBP). Your risk would no longer be in USDCHF but in GBPCHF.

Why I Hate Forex Hedging

The retail forex hedge involves no risk other than paying an extra spread if you want to close it out immediately. I have less of an issue with someone using it to book a profit with the intention of re-establishing the position by closing out the hedge if a retracement follows. Even then, what do you do if the market doesn’t correct as expected? Do you try to leg out of the hedge or simply close it out and start afresh?

Where I have an issue is when a trader uses retail forex hedging to avoid booking a loss by taking an opposite position in the same currency for the same amount. This is effectively closing out a position and taking a loss (see what your account balance says) but giving the appearance of having two opposing positions when your net exposure and risk is zero.

The plan is then to trade out of each side at a profit and recover your loss. So instead of taking your loss (as professional traders would do) and looking at the market with a fresh eye, a trader hedging a loss will look to sell out the long side on a rally or buy the short side on a dip.

This may work if you get lucky but you may find yourself buying a dip when you should be selling and vice versa on a rally. Then what do you do? Compound your loss by restoring your hedge at another loss when the market moves against you. The point is your trading decisions may be clouded by trying to trade out of opposing positions in your portfolio rather than looking at the market with an objective eye.

I cannot explain why traders like to hedge other than for psychological reasons. Maybe it is easier to close a position out (i.e. one side of the hedge) than to initiate a new one? Maybe it is less damaging to your psyche to feel you have not taken a loss when in fact you have already done so. Whatever the motive, forex retail hedging can cloud one’s judgment and seems to benefit the forex broker more than the trader. To sum it up, I hate hedging.

Note hedging is not permitted in the United States.