Published on: 2023-06-05
Updated on: 2024-07-11
What is Hedging?
Hedging refers to an investment that deliberately reduces the risk of another investment, therefore it is an investment behavior typically used to reduce commercial risk while ensuring one's own profitability in the investment. The specific operation is to simultaneously carry out two market related, opposite direction, equal number of transactions, and make up the profit and loss. In this way, one gain and one loss is hedging.
Hedge trading is most common in the forex market, aiming to avoid the risk of single line buying and selling. The so-called single line buying and selling refers to buying short (or short position) when bullish on a certain currency, and selling short (short position) when bearish on a certain currency. If the judgment is correct, the profits will naturally increase; But if the judgment is wrong, the loss will not be greater than not hedging. The so-called hedging refers to buying a currency at the same time and doing short buying. In addition, it is also necessary to sell another currency, namely short selling. In theory, buying short a currency and selling short a currency require the same silver code to be considered a true hedging position. Otherwise, if the two sides are different in size, the hedging function cannot be achieved.
The reason for this is that the world's forex market is measured in US dollars. All foreign currencies fluctuations are relative to the US dollar. Strong US dollar, i.e. weak foreign currency; If a foreign currency is strong, then the US dollar is weak. The rise and fall of the US dollar affect the rise and fall of all foreign currencies. So, if you are bullish on a currency but want to reduce risk, you need to sell a bearish currency at the same time. Buy strong currencies and sell weak currencies. If the estimation is correct and the US dollar is weak, the strong currency purchased will rise; Even if the estimation is incorrect and the US dollar is strong, the buying currency will not fall too much. The weak currencies that have been sold short have fallen heavily, resulting in losses and gains. Overall, they can still make profits.
In fact, the principle of hedging trading is not limited to the forex market, but it is more commonly used in the forex market in terms of investment. This principle also applies to the gold market, futures, and futures index markets.
Hedging Trading Models
1. Hedging of stock index futures: Participate in both stock index futures and spot market trading, or simultaneously trade different (but similar) categories of stock index contracts with different maturities to earn price differences.
2. Commodity futures hedging: When buying or selling a certain futures contract, selling or buying another related contract, and simultaneously closing both contracts at a certain time.
3. Statistical hedging: buying relatively undervalued investment products (stocks or futures), short selling relatively overvalued products, and gaining profits when the price difference returns to equilibrium.
4. Option hedging: Pricing rights and obligations separately, allowing for unlimited returns while ensuring limited risk losses.
5. Fixed increase hedging: When investors participate in targeted issuance, using stock index futures for hedging is an optimal solution to lock in returns and reduce risks.
Institutional investors who want to participate in hedge trading need to pay attention to learning hedge trading knowledge and establishing a suitable hedge trading model, which is the fundamental to long-term profitability.
【 EBC Platform Risk Reminder and Disclaimer 】: There are risks in the market, and investment needs to be cautious. This article does not constitute investment advice.
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