Hedging Forex Trades with Currency Binaries

Spot Forex trading is increasing in popularity because small movements can lead to big profits. Of course, the flip side is that small movements can also lead to big losses. In some cases, putting in a stop loss order is not sufficient – especially since if the stop loss order is triggered, you lock in losses.

In order to reduce some of the risk of spot Forex trading, and limit losses, adding a hedge to your trading strategy can help. One of the easiest ways to hedge is with the help of binary options on currencies. Trading binary options can help you hedge your losses, and improve your overall performance on the spot Forex market.

What is Hedging?

When you hedge, it means that you trade against your initial inclination. If you enter a short Forex trading position on EUR/USD, your hedge trade would be something that reflected a gain for the euro over the US dollar.

Using binary options can be a smart way to hedge against your positions, especially if you have a stop loss of 30 to 40 pips. When you think about it, such a large stop loss results in a $300 to $400 loss on a standard lot in Forex trading. That’s a lot of money to lose. However, you may not want a smaller stop loss during times of market volatility because selling could be triggered much sooner than you would really like.

Hedging can help you overcome some of these concerns. Your hedge should be sufficient to offset your stop loss, should it actually be triggered, but not enough to cause a problem if you are right and you lose money on your hedge trade. This is where binary options trading can come into play.

Using Binary Options as a Hedge on Spot Forex Positions

With this strategy, you enter a Forex trading, and place a stop loss order. Next, you trade binary options. Binary options come with expiration on the half hour, hour, day, week, and month (the most popular options are half hour and hourly expiry, since it’s a little easier to see where the trend is going in the very short term). This is especially helpful if you want to hedge your Forex position in day trading, swing trading, and scalping. Here is an overview of how it might work to use binary options as a hedge:

Say you enter a long position – trading on the daily charts – on EUR/USD when it is at 1.2240. Your stop loss is set at 40 pips below. That means a $400 loss (assuming a regular lot-size of $100,000) if your stop loss order is triggered. After you enter your position, you go ahead and buy five options contracts at a cost of $20 each, expecting that EUR/USD will reach a certain, lower price at certain time. Each of these options contracts, if you are right, will pay you $100 upon expiration, for a total of $500.

If you are wrong with your binary options trade, you only lose the $100, which is the equivalent of 10 pips on the spot Forex market. Of course, if your binary options trade is wrong, and EUR/USD rises as you expected, you come out ahead. If EUR/USD gains 30 pips, you have a net profit of $200 once you factor in the cost of your binary options. If you are wrong, though, and your stop loss is triggered at 40 pips down, you still come out $100 ahead, since your binary options hedge trade turns out to be right.

As you can see, a binary options hedge trade can be very valuable in terms of helping you limit losses from the spot Forex market. You can let your position ride a little longer, and with the right binary options hedge, it’s possible to make money, even when your spot Forex position loses.

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