Imagine a situation that offers you the chance to rectify your mistakes with a minor penalty. Would you accept it? You definitely should!
What is Binary Hedging?
Hedging is a method for mitigating capital risk in trading. It involves simultaneously opening both Put (Sell-side) and Call (Buy-side) options. This strategy, where two trades run in opposite directions, effectively minimizes losses. Particularly in the realm of binary options, losses are inevitable, but they remain lower than the initial investment.
Consider this illustrative scenario: we initiate a buy-side trade on the Volatility Index (synthetic indices) with a 100x return, and subsequently place a sell-side down trade on the same index, also with a 100x return. In both instances, our risk amounts to just $1, while the target return is $100.
By entering both trades, if one happens to incur a loss, the other trade remains profitable. This dynamic allows us to either generate profits or curtail the overall loss incurred from a single trade.
As depicted in the profit statement above, we earned 19 cents from one trade and experienced a 12-cent loss in the other, resulting in a net profit of 7 cents from this slot.
When Should You Hedge?
Should your trade deviate from its intended direction, hedging can come to your rescue. You can place a hedge trade of equal stake size to mitigate the risk.
In the earlier example, when our trade went counter to the anticipated trend, we executed a contrary-down trade. This move capped the loss at 21 cents, instead of the full 0.36 cents we would have lost if we closed the trade without hedging. Thus, employing this approach enables you to safeguard your finances through hedging.
Benefiting from Trade Closure:
In the given illustration, the trade yielded a profit return of $1.95. However, if we opt to end the trade before its expiry time, we could secure $1.22, translating to a 22-cent profit instead of the initial 95 cents. This strategy proves useful when anticipating a trade to turn against predictions.
Hedging revolves around achieving a balance in your trade risk. Consequently, precise calculations are imperative before initiating a hedge trade. By using hedging strategically, investors can salvage significant sums of money, even when confronted with a failed trade.