For those unfamiliar with the forex market, the word hedging ("to cover") probably means absolutely nothing. However, those who trade regularly know that there are several ways to use this stock market and forex trading term. Most of the time that you hear this phrase, it means you are trying to reduce your risk. This technique can protect your investments to some extent.

Hedging in forex trading is much like an insurance plan. When you cover yourself, you are insuring yourself in the event of a negative event. This does not mean that you will get away with no losses, but if you protect yourself well, the negative impact will be minimized. This acts just like auto insurance. You buy it in case something goes wrong. It does not prevent bad things from happening, but it can allow you to survive more easily.

All traders involved in transactions involving financial speculation should learn hedging. Among large corporations and even small individual investors, hedging is very common. It involves the use of instruments in the financial markets to offset the risk of a negative price movement. The best way to do this is to cover an investment with another investment. For example, by investing in two different products with negative correlations.

Hedging has a cost, but the protection you get by doing this is well worth the price most of the time. Studying the use of hedging can also improve your understanding of the correlations between different underlying assets. The techniques used for hedging are generally conducted with derivatives, futures, contracts for differences, options and currency pairs. These instruments are often used by sophisticated investors.

When you decide to hedge a position, you must be aware that this has a cost. It is therefore necessary to calculate the benefits obtained to make sure that the expense is justified. The objective of hedging is not to make money but to reduce losses. Forex trading losses cannot be avoided, but hedging provides additional security.

Even if you choose not to use hedging in your forex trading strategies, learning this technique is a great way to understand the fluctuations of financial markets and to understand the trading strategies used by large investment companies, hedge funds and professional traders. No matter what, you will benefit from knowing about hedging and how it works.

Author's Bio: 

Elodie Dutronc has been trading both stocks and forex for years. She scoops up stocks during recessions and trades currencies at all times, mainly using a hedging technique that takes advantage of highly volatile markets. For some forex trading strategies, a forex broker comparison or forex affiliate info, please visit her website.