The concept of hedging is yet to gain prominence in forex trading, and this is mainly owing to the legalities and policies of various brokers that continue to profit from taking positions against their customers. If you use an ECN broker, which we recommend that you should, there are various hedging strategies that you can take advantage of, which can significantly alter the risk / reward ratio in your favor.
A well-thought-out hedging strategy helps you dodge losses or at least limit them to a known amount. In this article, we are exploring a relatively unknown forex hedging strategy called “Triple Hedging”, which involves hedging three currency pairs at the same time. In this article, we try to help you get a complete understanding of the concept of the triple hedge, helping you successfully spot opportunities and execute trades that have high probabilities of success.
Triple Hedge Forex Strategy – What You Should Know?
Every hedging strategy involves having a position you buy and the position you sell. For every position, you buy or sell, there is another position which does the opposite buy and sell to protect this initial position.
The reason Triple Play Hedge is better than other mainstream hedging strategies is that in conventional strategies, you generally need to spend more money and sacrifice some of your potential profits in order to have an insurance cover over your investments.
It’s recommended that traders stick to the major currency pairs for this strategy, since such currencies are highly interlinked to one another, and thus, provide plenty of opportunities for hedging. In minor pairs, with less liquidity and volatility, there is always a possibility that they don’t perform as expected.
Other factors you should take into consideration are – you’re capital, the amount of time you can spare to find, execute and monitor trades that you put into action.
Hedging 3 Currency Pairs – How It Works?
Traditional Currency Hedge
Let’s take for example these two currencies – EUR and USD.
If you are in a “buy” of “EURUSD” then you would have to open a “sell” in the EURUSD. This would hedge your positions as no matter which direction the currency moves, the profits and losses will be offset.
In the above transaction, you have-
- A buy in the EUR that is offset by a sell in the EUR
- A sell in the USD that is offset by a buy in the USD
That’s how a traditional hedge works. It may not result in any gain or loss in normal circumstances, although the spread you pay would pretty much guarantee a loss, but this strategy does make sense when you’re expecting big movements in the market, and would like to take advantage of the movements without risking the downside. Once the direction of the market is certain, and it continues to gain momentum, you can close the loss-making trade and maximize profits from the profitable one.
Multiple Currency Hedge – Double Currency Hedge
When hedging two currencies, you two take positively correlated currency pairs and take positions on them in opposite directions.
- You take a short position on EUR/USD and open a long position on GBP/USD.
- Now, if the Euro falls against USD, your long position on GBP/USD takes a loss.
- However, that loss will be mitigated by profit on your EUR/USD position.
- If USD falls, your hedge will offset any loss caused by your short position.
Here, you’re hedged against exposure to the dollar but have exposed yourself to the GBP & the Euro. Dealing with multiple currencies come with their own risks, there is always a possibility that one position losses more than the other gains, resulting in a net loss, which is often the result of slippages.
Multiple currency hedge – Hedging 3 currency pairs
Now let us look at an example of a multiple currency hedge. Assuming the same lot size, we are taking EUR, USD AND JPY currencies.
In this case, if you,
- Buy the USD/JPY
- Buy the EUR/USD
You are effectively buying the EUR/JPY because the USD parts cancel each other out. In order to create the hedge, you need to sell EUR/JPY. This is how the equation will look like now,
- Buy the USD/JPY
- Buy the EUR/USD
- Sell the EUR/JPY
There, you have a hedge
You form a hedge here because,
- With the EUR, you have both a buy and a sell
- With the USD, you have both a buy and a sell
- With the JPY, you have both a buy and a sell
That’s a perfect hedge
That’s a practical example of using multiple currencies to hedge your transactions. Of course, you can play around and hedge any three of these transactions by following the same formula given above.
There is a bit of math involved so for the initial stages you can get a pen and a paper and cancel these currencies out as you are doing these transactions.
Here are a few more examples of multiple currency hedging for your reference.
Is Hedging In Forex Illegal?
While hedging is accepted by various traders and investors across the globe, hedging particularly in the forex market has a unique angle to it which makes it illegal in several financial markets, especially in the US.
Buying and selling the same currency pair at the same price or different strike prices is considered to be illegal. The Commodity Futures Trading Commission (CFTC) has put several restrictions on forex traders and a key restriction among them is to hedge a position on the same currency pair.
In order to curb hedging and make sure all the traders and brokers adhere to the laid out rules, the CFTC has instructed brokers to integrate OCO (One Cancels Other) order into their trading platform. This prevents traders from hedging on the same currency pair.
Except for the US, hedging is used as a legally accepted trading strategy by a majority of brokers globally including those from Asia, Europe and Australia.
Forex Hedging With 2 Accounts – Getting Started
Although hedging is illegal in the US, the ban is not absolute. There are other ways you can work around the rule and one of them is to open two separate accounts. This is how you get started,
- You can open two broker accounts with the same broker or different ones.
- Next, short a currency pair in one account and go long on the same in another account.
- This way you can seamlessly form hedging pairs.
So there you have it, a quick overview of how to trade by hedging three currency pairs together. This type of strategy takes time and patience for an opportunity to arbitrage the markets. There are many types of strategies using hedging as a form of arbitrage to lock in profits over time.
As long as everything adds up, this is always worth a shot if you are finding trading forex a bit too fast.
Hedging like this can be a specific strategy in the background, whilst you focus on other trading strategies that can be used more aggressively throughout the day. It’s entirely up to you.