Hedging Strategies

When it comes to premium grade trading strategies and approaches, none is arguably more professional than hedging. Hedging is a process the institutional investors spend heavily on getting right, and much of their graduate training programmes focus on what hedging is and how to spot hedging opportunities. While hedging is an invaluable tool for diversifying your portfolio and eliminating much of the risk profile to which you would otherwise be exposed, it is nonetheless a tricky technique to execute effective, and one that requires a considered strategic approach.

Trading In Pairs

One of the first elements of hedging that most funds and private investors will take on board is a strategy of taking on hedging pairs. Hedging pairs are coupled transaction that are designed to have an offsetting impact on each other, in order to produce an trading outcome that is profitable regardless of market movements up or down.

The idea runs that the trader will select a couple of inversely related trading positions, in the hope that when one moves upwards it will offset any correlative losses in the other and vice versa. Essentially, the aim is to create a situation where the risks are reduced, by building in inversely related positions that will over the duration of the transaction deliver an overall profit.

Industry Comparisons

A further strategy often employed by hedgers is in comparing industry hedges, rather than two distinct and separate assets. It may be the case that the hedger wishes to compare two futures contracts to provide a hedge against other positions, just across different interrelated assets and/or markets. Rather than trading in direct pairs, it might be the case that a trader decides to set up a hedge to deal with related industries, for example oil futures and airlines, in a bid to create a hedge proposition to cut down on the risks of trading.

Instrument Hedges

A third type of hedging behaviour concerns hedging different instruments against one another, sometimes in very closely related assets in order to produce the desired effect. Particularly with the advent of more complex and ultimately functional derivatives, coupled with the broadening of the market for these instruments, hedging in this sense is becoming increasingly widespread, allowing traders to effectively guarantee themselves the better of two trading outcomes without comparative downsides.

Hedging strategies, while designed to counteract the risks of wayward positions, particularly for highly leveraged transactions such as futures contracts, can be essentially very difficult to gauge exactly, and in some instances it’s simply a case of damage limitation. That said, by building in a component of hedging into your portfolio, you can help strengthen your aggregate capital position for a strong, more profitable trading future.

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