How To Reduce Your Forex Trading Risk With Options Hedging

How To Reduce Your Forex Trading Risk With Options Hedging

The Forex market has got a pretty bad reputation during the past several years. In my opinion this has happened because of the less transparent brokerage houses (saying it short scammers) and because the traders that get into this train believe that it is a short journey to becoming rich.

To become profitable on the Forex market you need first to study it. Learn what are the factors that move the market, how the price is made, find yourself a strategy, get some discipline and start practicing with a risk as low as possible. It can become a full time job, but if you think you will get yourself rich after a day, a week or even a year with risking too much and no discipline, you will find yourself thrown out of a running train.

Traders should try to risk as less as possible and leave the market to run in their favor as much as possible. It is easier said than done, because while trading with real money emotions like fear and greed tend to appear. When the trader is surrounded by these emotions he tends to do stupid things. We will tell you in the next paragraphs a method that will help you reduce your risk while trading on the Forex market, but no one can show you how to manage your emotions, and for this you need to practice, practice and practice.

A good strategy to diminish the risk on the trades made on FX is to buy different types of options on the same instrument. You could ask: why buy and sell on the same type of instrument? Well, it would be pretty difficult to get out of that hedge with a profit on a way or another.

A trader can use different types of options depending on the strategy that he uses and especially on the time that he expects to keep the trade opened. Let’s take some simple examples:

If a trader uses a scalping strategy and he would at some point try to catch a bigger move on a very short time interval (best example would be what happened yesterday, 18 September 2013, on the FOMC meeting), he could use a very fast binary option on the other direction. This way if the price would not go in his direction could catch a profit on the option evolution.

Let’s say that the strategy used is not a very short term strategy, is rather a system that offers signals for trades that could last up to several days. In this case the trader could use European Digital options (Above/Bellow a specific level or Inside/Outside a range) and set up an expiry date for the option close to the day that he estimates he will close the trade.

If the trader is a position trader then he would need to hedge his trades on a longer term. In this case it is recommended to be used the Vanilla type options (Call/Put options). This way he will be able to win if the trade would go against his direction.

One important aspect that should always be taken into consideration is the money management. The premium paid for the option should be less than the potential profit made on trading, let’s say the CFD. The payout for the option should be equal or bigger than the stop loss set on the CFD.

 

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