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, each with its own characteristics and pursuing specific goals.

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

The "Classic" hedging method fully covers risks by simultaneously opening positions in opposite directions on the underlying and derivative assets. For example, an investor may decide to purchase a stock with the expectation of future growth, but there is a significant risk that its price may decline.

To offset the risks, an investor can purchase a CFD on the same stock's decline. This way, at the moment the trade is executed, the investor will ultimately have zero risk, since if the stock price falls, the profit from the CFD contract will reduce the loss to zero. What does the investor gain from such a transaction?

The first is the dividend payout on the stock, and the second is the availability of the stock itself, acquired with zero risk. The classic method is used precisely for the purpose of preserving funds. However, this example is not a panacea, so both futures and options can be used instead of CFDs.

The second method of hedging.

The method most commonly used by traders is called "Partial Hedging." The name speaks for itself, as you might have already guessed, hedging in this case involves only a portion of the underlying asset, not the entire amount.

Why is this done?

Let's say a trader buys a million pounds for dollars, anticipating further appreciation. However, realizing they could suffer losses, they immediately buy a put option worth half the original contract. This way, if their prediction is correct, they make money, and if it's wrong, the put option will offset 50 percent of their losses.

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

This method is primarily applied to the stock market. The catchy name conceals a simple concept. For example, you, as an investor, want to buy shares, but you understand that their value will rise in the future, and you currently don't have the opportunity to buy.

Therefore, you buy a futures contract on the same stock at a fixed price, anticipating that you'll save money on future purchases. This method essentially involves purchasing the futures contract first, and then the stock itself.

The fourth hedging method is called “Cross”.

The idea is that you buy a futures contract not for the underlying asset, but for a completely different one. This method is based on the trader's trading tactics and personal observations. For example, some traders buy gold when oil prices fall. This method is somewhat similar to arbitrage, which uses specific assets with a high correlation .

The fifth hedging method is called “Selective Protection”.

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

There is no set formula for this method, and all transactions are conducted purely based on the manager's subjective opinion. However, in general, the manager, through such operations, insures certain assets fully and others partially, with the primary goal being to profit from exchange rate differences while minimizing losses.