The Only Simple Hedge in Forex: Incorporating Binary Options as a Hedge
Few Forex traders can tell you about hedging in Forex trading, quite simply because there is no simple hedging tool within conventional Forex trading. Hedging instruments that do exist within Forex are not well known, such as vanilla Forex options, and pose liquidity issues. Also, and perhaps the most obvious reason Forex traders don’t think to utilize hedging, is that Forex traders cannot hold the same position in both directions.
Yet there is a way to hedge your conventional Forex trading and it is actually quite easy to do: purchase Forex Binary Options in conjunction with your conventional Forex trading as part of your overall trading strategy. When used correctly, if you incorporate a Forex Binary Option trade with your conventional Forex trade, you will successfully hedge against your conventional Forex loss even further (maybe even actually turn your loss into a profit) when your Forex trade goes sour.
As a conventional Forex trader, you may already be familiar, or at least casually know about, Binary Options. Since Binary Options provide a fixed payout with no spreads or commissions involved, they make excellent and stable hedging tools when used in combination with your conventional Forex trades. Let’s explore a simple example of combining Forex and Binary Options:
In the chart above, the AUD/USD breaks out of a base. A typical Forex strategy will involve a long position on the AUD/USD combined with a Stop-Loss. So if you believe that the AUD/USD ’s breakout will succeed you could buy $100K AUD/USD and then place a Stop-Loss 10 Pips below the breakout point. This conventional Forex trade offers an unlimited upside and $100 downside if the breakout fails and the Stop-Loss is hit.
To hedge this conventional Forex trade, we now add a Binary Option trade, which will decrease the total downside to $0 if the Stop-Loss is hit. For example if you also buy an 80% payout $125 AUD/USD PUT Binary Option at the breakout point, then you will profit $100 from the Binary Option if your Stop-Loss is hit, fully offsetting your Forex loss. Of course, it is best that you capture more than $100 profit on your long Forex position as this is your downside from your PUT Binary Option. To do this, you will want to exit your long Forex position after a move up of greater than 10 pips.
If this was a real trade, you would have just incorporated a strategy that has unlimited upside and $0 downside. Utilizing a Binary Options and Traditional Forex combination strategy highlights how you, as a Forex trader, can now bring in the use of your own easy-to-use hedging instrument into your conventional Forex trading.
