Stop Loss and Hedging are methods to limit losses in forex trading. Do you know that hedging can actually be used as an alternative to Stop Loss?

Stop Loss and Hedging are both methods to limit losses in forex trading. Usually, the two are seen separately, with hedging often used as trading strategy instead of a way to limit losses. However, hedging actually can be used as an alternative to stop loss as well.

 

Stop Loss and Hedging

Stop loss means we placed an automatic order to close a certain position when price touch a certain level where that level is the limit maximum loss we can bear. Apart from the automatic Stop Loss, traders can also use Cut Loss in which we manually close the aforementioned unfortunate trade. The two are usually used to prevent major losses that may bring our account balance to touch Margin Call (MC), or even enter negative balance. Psychologicaly, Stop Loss is more certain because it will not evoke doubts; a position will surely be closed as soon as it arrived at a certain point. However, manually cutting losses offer more flexibility as we can decide ourself whether to cut a trade or let it go on depends on the most current situation.

And then, there is Hedging (also known as locking). Hedging or locking means that we open buy and sell position at the same time or without closing the other position. In practice, we can use pending order or instant execution to protect a trade.

Many traders choose hedging to prevent losses because they want to limit loss with more flexibility. It means that the amount of losses will be limited, but there will still be hope for positions that floats in the negative to be closed at a profit. If managed well, hedging can end up with overall profit. However, it needs patience, precision, and discipline in margin management. Many hedging ended as one more position floats negatively, thus spurred the account into an MC.

 

Manage Hedging

Main difficulty in hedging is in margin management and locking opening. Opening locked position often incur indecision among beginner forex trader about when is the correct time to open locked position or closed hedged positions. The question that commonly registered is, Close now, or later? If I close it now, what if the trend is still going forward, so the loss trade got higher while the one with profit closed too early. But if I don't close it now, who knows if the trend revert back and foil my plan to get profit.

Doubt
Extra patience and confidence are needed when we open locked positions. A friend who used to utilize hedging suggested to open lockings and keep the position while scalping to cover losses if the trend still go on afterward. Of course, this technique wil need composure and steady nerves on the traders' part so that we will not be easily tricked by fake movement on the chart. Beside of that, it is also advisable to use hedging only when our available margin is bigger than used margin. When available margin has depleted, it is better to make use of Stop Loss or Cut Loss.

 

Hedging As Stop Loss Alternative

Using hedging as an alternative to stop loss can be done in two ways:



1. Instant Execution

Hedging with instant execution is done by opening a new position in the opposite direction to the one that has been floating negatively in the same currency pair in order to lock the first position.

For example:

We open Buy EUR/USD order at 1.3000 and then we suffered loss as much as 50 points (EUR/USD drop to 1.2950). We locked the position at 1.2950 by opening a new Sell EUR/USD order at 1.2950. This way, our losses will continue to float around -50 point until one of the two position is closed. It means, although price fall futher to 1.2500, our loss will still be -50 points.

 

2. Pending Order

Hedging with pending order means we place pending order on a certain price as protection for another position we have taken before. Thus, if price indeed deviates from our prediction when we are away from the chart, pending order will automatically active to prevent losses in previous trade.

For example:

We open buy EUR/USD order at 1.3000 and then place pending order (sell stop) at 1.2950 in the same pair. That way, if price goes down, then pending order will be activated and prevent losses in the floating position.

But there is a problem: how do we determine at which level to put pending order? I would like to suggest that since hedging in this case is aimed as an alternative to stop loss, then consider to place it using the same method you use to determine Stop Loss.

Still, psychological dilemma presented by using hedging as stop loss is still there. The friend I've mentioned above also suggested not to place Target Profit (TP) during hedging. Of course, there is another consequence: we have to stand by and patiently monitor the chart; when we feel the trend started to turn back, close the position that is in positive. If afterward it appears that the trend goes forward again, then open another hedging position, and so on. It means we will lose some spread, but it will feel better because we are able to take bit by bit advantage from price movement. Hedging as an alternative to stop loss is not advisable for beginner traders, but it can be beneficial for traders who feel the need for more flexible stop loss.

No matter what kind of stop loss we choose, it have to be suitable with our condition. Meaning, we have to be comfortable with whatever decision we take during trading. Enjoy every process in forex trading. Don't let forex trading result in illness for you, that is making you lose time, energy, and money, plus giving you heart attack to boot.