Imagine a situation which offers you to fix your mistake with little penalty? Will you accept it? Obviously, you would or you should! When we shoot gun we can not take the bullet back to the gun shell again. But luckily in the financial market, we can save 90% with 10% loss out of 100%. This is the reason why hedging plays an important part in financial binary options trading.
What is Hedging?
Hedging is a way of decreasing capital risk in trading. It is done by opening both put and call options trade altogether. Having two trades open in opposite direction to reduces the losses. Positively in case of binary options, there will be some losses but that loss will be lower than the original one.
Suppose you have placed put options on EURUSD thinking that EURUSD will move down by risking $100. But unfortunately, it moved up instead of down, so if you lose will lose the invested $100. But if you are confirmed that your trade is going to be a loser. Then if you place another call option trade with EURUSD with the same amount of money. Then winning that trade will fetch $90 (say with 90% return on winning). Your net loss will be $100-$90 = $10, therefore you save capital 90% from the loss.
Losing $10 is better than losing $100.
What are the best market conditions for hedging?
Hedging is suitable best on the trendy market. When a market is trending up or down without many noises, those are the best time to place hedging trades.
Indicator to indicate the trendy market for hedging:
The market trend is best spotted with the volatility indicators such as Bollinger bands, Average true range (ATR), bull power, bear power etc.
Bollinger band & ATR are the most commonly used non-lagging indicator for trend detection. In the picture below you can see for multiple forex currency pairs, we can easily location which currency pairs to pick for hedging with Bollinger band.
SFX Multipair Trend Dashboard Indicator for Metatrader 4
With the indicator screenshot above, we can see there are lots of volatility spikes with Bollinger band bullish or bearish breakout, plus ADX trend was also visible along with ATR. This was for 1 minute chart during the Asian session. If you test it during the London session then you will find better examples or especially before any forex news release.
When you should not be hedging?
With the 1st example, if the market was in range, neither moving upward or download, then instead of losing only $10, you would lose $200, (double of the original). This the major risk with hedging. So never place hedging trade on range market, otherwise, you lose double or more, depending how many trades you placed.
Remember binary options trades are time specific, unlike the spot trading. So if your 2nd trade doesn’t get profitable in time, then you will lose money on both sides. This is the reason, you need to be aware of trend power while placing the 2nd opposite direction trade.
Before placing hedge trade ask yourself, is there any possibilities that market will move down in next 30 minutes. This their any financial news is going to release that can move the market in my favorable direction?
How important is keeping the hedging price same?
If you place your 1st trade on 50 then placing the hedging trade in the opposite direction at 50 will be the best options. This way your hedging trade will be bulletproof. But not always placing a trade in such manner is possible, especially with binary options.
Some broker even does not support to place opposite trade on the same price level.
How to make profit with Hedging?
So far we have shown you the example to reduces losses with hedging. Now you will learn how you make a profit also. But remember this a risky process.
The most common way of doing it with double or multiple lots.
For example, you have placed put options with EURUSD risking $100, you have predicted that EURUSD will fall in next 60 minutes, after 30 minutes you are seeing that EURUSD instead of falling its rising upward direction, it moved above your price entry point. If you feel the uptrend is powerful than the downtrend, you can place 2 call trades with EURUSD around the same price level for rest 30 minutes, risking $200.
So, if after 30 minutes EURUSD keep moving upward, then your net profit would be with 90% return,
$200×90% = $180 – $100 = $80
Example with GBPAUD:
During the forex Asian session, we placed call options on GBPAUD for 6 minutes, that market will stay up from the entry price for the next 6 minutes. But after 3 minutes past, our trade call options trade was still in losing position. So we hedge for next 3 minutes put options.
Binary Hedging Profit Loss Statement
You can see with the above account statement, the net loss is $2.25 instead of full $10.00. Therefore this trade saved money.
Hedging is an advanced way of trading, therefore requires proper knowledge on statistical analysis of your trade. Before placing hedging trade you need to consider the risk and the reward altogether. You do not want to end up on the wrong side without considering the profit factor.
By practice, you can always improve this over time.
Practice this binary options hedging strategy FREE on demo account.