Before understanding forex hedging, one should understand hedging which is a financial term and is used to diminish the losses. It also implies taking precautions in the finance to avoid the irregular conditions. So in case of forex trading, it will be used for defending the losses or risks against the fluctuating exchange rates in the trade market. This would be true especially while buying or selling some sort of currency pair.

No trader would like to have losses so they use various techniques to minimize the risks against the irregular exchange rates. Most common strategies used is derivative, which includes generally multiple currency pairs or currency hedging to counteract against the future losses.

Currency pair can be understood as pair of two currencies which makes the exchange rate. When one of them is sold then other will be bought or vice versa. Trader may go for long or short position, as in long position trader try to get profit when the price is rising and on the other hand short position trader try to avail gain when price is decreasing. So by using forex hedging short and long position trader both can protect themselves from upside and downside risks.

Hedging can be used by traders by using the difference in the interest rates or the charges given to the two brokers. In case of two brokers one needs to have open position pair with same currency pair with both the traders, one of whom pays interest at end of the day while other does not change interest.

Trader may use another way for hedging as well. When it seems that price is going down for one currency pair then one may opt for selling another pair to cancel out the effects of price change.

Forex hedging can prove to be a boon for the experienced traders, while it can be harmful if used without knowledge of market. It is advised not to use hedging techniques in retail as this may increase the risks.

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Reasons for using a Forex Hedge

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