FX Hedging Policy
Hedging is a strategy that involves placing trades in opposite directions on the same currency pair at the same time. This strategy was used by many FOREX traders over the years until it was forbidden by the Commodity Futures Trading Commission for traders with brokers in the United States.
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Function
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The purpose of hedging in FOREX trading is to limit risk. With this strategy, you place a buy order and a sell order on the same currency pair. Then, regardless of which direction the market moves, you can take a profit. You do not have to place live orders to hedge, as you could use pending orders to do the same thing without taking as much risk. Several trading strategies were built around the ability to hedge positions.
Risks
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Even though painting could potentially help you lower your risk, there are some risks inherently associated with hedging itself. When you take two positions in opposite directions in the FOREX market, you could potentially lose on both trades if you do not monitor the market carefully. If the market moves up significantly and then back down again, it could take out both of your orders with large losses.
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CFTC Regulations
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The Commodity Futures Trading Commission, or CFTC, works in conjunction with the National Futures Association, known as the NFA, to regulate FOREX brokers in the United States. In May 2009, they made a rule that made it impossible for customers of these brokers to continue hedging. They instituted a rule known as "first in first out," which means that you have to close positions in the order in which they were opened. This prevents you from hedging in your account.
Prevention
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To prevent hedging from taking place, brokers in the United States essentially close out one of your trades when this occurs. When you try to hedge your positions, it will result in you not having any position in one direction. This can cause significant risk to your account if you are unaware of the regulations involved with hedging in the United States.
Benefits
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The benefit of this regulation is that it can help clarify trading strategies for traders in the United States. Most professional traders do not engage in hedging activities because it is arguably ineffective. By removing the temptation to hedge in the first place, the NFA has taken steps to protect new traders in the FOREX market. It is unknown exactly what good hedging did for traders to begin with.
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