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Hedging

Write By: admin Published In: ROOT Created Date: 2016-01-26 Hits: 563 Comment: 0

Traders of the financial markets, small or big, private or institutional, investing or speculative, all try to find ways to limit the risk and increase the probabilities of winning. There are many trading strategies out there and hedging is one of them. In fact, hedging is one of the best strategies to do just that, that's why many large institutions use it as a mandatory component of their tactics. There are even investment funds that are named after this strategy, because they 'hedge' most of the trades and that's why they are called 'hedge funds'.

In most industries, in order to limit the risk of loss you should buy insurance. This applies to the financial markets as well, but in order to avoid the insurance fees, the hedging technique has been developed. The futures market was founded in the 19th century to protect the traders from potential losses from price fluctuations of the agricultural commodities. To hedge means to buy and sell at the same time or within a short period two different instruments or stocks either in different markets like options and stocks.
In Equity, hedging is a very commonly used strategy known as “PAIR TRADING”. To hedge a trader has to choose two positively correlated pairs and take opposite directions on both. Hedging is meant to eliminate risk loss during times of uncertainty and it does a pretty good job of that.
But safety can't be a trader's only concern while trading; otherwise it would be safest not to trade at all. That's why we use technical and fundamental analysis to make the hedge technique profitable, not just safe. This is where the analytical ability that will make you a profit while you take opposite positions on correlated pairs will come into play.
When deciding to hedge a trader should employ analysis to spot two correlating pairs that will not act exactly in the same way to the upside or downside movement.

To summarize, hedging is not a strategy for predicting which way a certain stock pair will go but rather a method of using the market to your advantage even if you don't know. Hedging provides an 'insurance policy' for trading on the stock market and if you do it right you can guarantee that you never lose another trade again.

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