What Is Hedging in Trading?

Why traders and businesses hedge

Hedging is widely used outside trading. An airline may hedge fuel costs, and an exporter may hedge the currency it will be paid in. In both cases the aim is to reduce uncertainty, not to make a profit from the hedge itself.

Individual traders sometimes hedge for similar reasons: to protect an open position through a period of uncertainty, such as a major data release, without closing it.

This guide explains how hedging works and its limits. It is educational and does not recommend any strategy.

Common types of hedging

The examples below are hypothetical and for illustration only.

Direct hedge. Holding a buy and a sell position of the same size on the same instrument at the same time. For example, a trader holding 0.10 lot long on EUR/USD opens 0.10 lot short. While both are open, further price moves largely cancel out. The position is effectively frozen, though costs such as spreads and swaps continue.

Correlated hedge. Using a different instrument that tends to move in a related way. EUR/USD and GBP/USD, for instance, have often moved in the same direction, so a long position in one might be partly offset by a short in the other. Correlations change over time, so this kind of hedge is imperfect.

Cross-asset hedge. Offsetting risk in one market with a position in another. A trader with exposure to equity indices might hold a position in a traditional safe haven such as gold, on the expectation that the two may react differently during market stress. That relationship is not guaranteed. See our guide to safe-haven assets.

Partial hedge. Offsetting only part of a position, such as hedging 0.05 lot of a 0.10 lot trade. This reduces exposure without removing it entirely

The costs and limits of hedging

• It limits gains as well as losses. A hedge that offsets losses will also offset profits on the original position.
• Trading costs add up. Each leg of a hedge pays the spread and any commission. Both legs may also incur overnight swap charges.
• Margin is still required. Depending on the platform and account, hedged positions can tie up margin. See our guide to leverage and margin.
• Imperfect hedges can lose on both sides. If a correlated or cross-asset hedge stops behaving as expected, both positions can lose at the same time.
• It can delay a decision. A direct hedge freezes a losing position rather than resolving it, and the trader eventually has to decide which leg to close.

Frequently asked questions

Does hedging eliminate risk?

No. Hedging can reduce exposure, but it adds costs, can be imperfect, and still carries the risk of losses on one or both positions.

What is the difference between hedging and a stop-loss?

A stop-loss closes a position at a set price. A hedge keeps the position open and adds an offsetting one, which means costs continue on both.

Can you hedge on MetaTrader 5?

Yes, on accounts that use the hedging system, which allows buy and sell positions on the same instrument at once. Netting accounts combine opposite trades into one net position.

Is hedging a strategy for beginners?

Hedging involves managing several positions, costs and margin at once, so it can be more complex than it first appears. It is important to understand how it works before using it.

Risk warning

Trading CFDs on margin carries a high level of risk and may not be suitable for all investors. Retail clients could lose all of their deposited funds. This article is for educational and informational purposes only. It does not constitute investment advice, a recommendation or an offer to buy or sell any financial instrument. Past market behaviour is not a reliable indicator of future results.