Hedging methods. As a way to protect transactions

The main objective of Hedging is primarily to protect transactions and capital. This result is achieved by buying the underlying asset and selling the derivative, or vice versa.

Thus, the investor or manager carries out insured operations, thanks to which the risk of loss of capital is almost minimal, and the only thing the investor loses on is commissions for opening and holding orders.

However, hedging is primarily used in the stock market, where the main goal is to save money from a possible price drop, while various other instruments can be used to compensate for losses.

In the Forex market, hedging is used extremely rarely, however, some instruments specifically from the Forex market can be used individually to protect against losses of the underlying asset.

Basic hedging methods.

In practice, several different hedging methods are used, which have their own characteristics and pursue specific goals.

The first method of hedging risks is called “Classical”.

With the “Classical” hedging method, risks are fully covered due to the simultaneous opening of positions in different directions on the underlying and derivative assets. For example, an investor has decided to purchase shares with the aim of their future growth, but there is a high risk that they may decline in price.

In order to compensate for the risks, the investor can purchase a CFD for the fall of the same stock, so at the time of fixing the transaction, the investor will ultimately receive a risk value of 0, since if the shares fall in price, due to the profit from the CFD contract, the loss will be zero. What does an investor have with such an operation?

The first is the payment of dividends on the stock, and the second is the presence of the shares themselves, which were acquired with zero risks. The classic method is used precisely to save money. futures and options can be used instead of CFDs

The second hedging method.

Which is most often practiced by traders, is called “Partial”. The name speaks for itself, so as you can already understand, hedging in this case occurs not for the entire amount of the underlying asset, but for a certain part.

Why is this being done?

Let's say a trader buys a million pounds for dollars, assuming that the pound will continue to rise. However, realizing that he could make a loss, he immediately buys a call option for half the value of the original contract. Thus, if the forecast comes true, the trader earns his money, and in case of failure, 50 percent of the losses will be compensated by purchasing a down option.

The third most famous method of hedging is called “Anticipatory hedging”.

The scope of application of this method occurs mainly in the stock market. Behind the cunning name lies a simple essence. For example, you, as an investor, want to purchase shares, but you understand that they will grow in the future, and at the moment you do not have the opportunity to purchase.

So you buy a futures contract on the same stock at a fixed price, assuming you'll save on future purchases. Thus, with this method, the futures are initially purchased, and only then the stock itself.

The fourth hedging method is called "Cross Hedging".

Its essence lies in the fact that you are buying a futures contract not of the underlying asset, but of a completely different one. This method is based on the trader’s trading tactics and his personal observations. For example, some traders buy gold when the price of oil falls. This method is somewhat similar to arbitrage, where certain assets with a high percentage of correlation .

The fifth hedging method is called Selective Hedging.

It is based on the purchase and sale of an underlying and derivative asset, but the end time of the transaction and its volume may vary. 

When working using this method, there is no specific formula, all transactions are carried out purely according to the subjective opinion of the manager, however, to generalize in general, thanks to such operations, the manager insures certain assets in full, and others partially, and the main goal is to earn money in the difference in rates while minimizing losses .