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Forex spread betting hedging strategies

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Traders should only attempt spread betting after they've gained sufficient market experience, know the right assets to choose, and have perfected their timing. Long-Arm Regulatory Risk. Government of the U. City Index by Gain Capital. Hedge Funds Investing. Trading Instruments. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand.

What Is Spread Betting? Technical Analysis Strategies. Spread Betting Around Corporate Actions. Structuring Entry and Exit. News-Based Strategies. Arbitrage Opportunities. The Bottom Line. Key Takeaways Spread betting lets people speculate on the direction of a financial market or other activity without actually owning the underlying security; they simply bet on its price movement.

There are several strategies used in spread betting, from trend following to news-based wagers. Other traders look to capitalize on rare arbitrage opportunities by taking multiple positions in mispriced markets and putting them back in line. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.

You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Articles. Partner Links. Related Terms Long Put A long put refers to buying a put option, typically in anticipation of a decline in the underlying asset. Betting on a Modest Drop: The Bear Put Spread A bear put spread is a bearish options strategy used to profit from a moderate decline in the price of an asset.

Hedging involves taking an opposite trade that will offset any losses in the actual investment. Spread betting provides traders and investors alike with an excellent trading tool capable of protecting investments against unfavorable movements in share prices.

While some market participants are day traders in spread bets, others are investors who use them in conjunction with other investments as a way to mitigate risk or limit any possible harsh consequences of stock market volatility. Spread bets allows traders and investors to lock stock value at the present price by placing a down bet in the same stocks in their portfolios, which is especially useful if a market or share is about to fall in value. For example, such investors will go short in the market to benefit from falling markets to hedge against their existing shareholdings.

Additionally, spreadbets being margined transactions means that you are able to leverage short positions. So for a fraction of the underlying market exposure, you can undertake a hedging strategy. Because spreadbets are traded on margin, you only need a fraction of the total notional value of the trade in your trading account to open the trade. In this case you could take out a short position this is selling a share with the expectation that its value will decline if you are uncertain of how a stock will do in the future, but you want to keep hold of the underlying stock.

If they have, for example, a basket of FTSE stocks or securities, financial spread betting can prove to be very cost-effective mechanism of hedging that portfolio because there are no commission charges and also very low setup fees. You think that they might fall back to about p per share but wish to avoid selling them now to avoid creating a capital gains tax liability so you decide to take out a spreadbet. For instance, back in when the credit crunch was heavy underway, anyone who owned shares in a bank institution or home building company could have sold the spread-betting quote.

And while their underlying share value was going down, their spread betting would have offset the losses incurred on their shares positions. The temptation is to sell after such a jump and then buy back, but one could use a an opposing spread bet to lock in the financial gain more cost-effectively. Though here you have to take into account the opportunity cost of the margin funds as you have to keep this at the spread betting company rather than investing it.

This type of hedge is particularly effective if you have a shares portfolio which is overweight on a particular sector as shorting a key stock in that sector will help reduce the downside risk. Spreadbets can also be used to hedge against rising household costs, such as fuel bills, food prices and rising mortgage repayments.

That way, if interest rates rise more than expected, you will make money that you can use to offset higher mortgage repayments. If the exchange rate is, at say, 1. You can take a short trade for the equivalent value of your future property purchase to protect yourself against such a scenario. Note that hedging is designed to eliminate market exposure and is not a means to making an overall gain — it will simply ensure that you will always roughly breakeven.

Hence, hedging your portfolio does somewhat reduce the prospect for making additional gains but in certain circumstances it makes practical sense to cover your positions. Sometimes the best hedge is to let go of a losing position. It is worth noting that hedging costs commissions in terms of the bid-offer spread and increasing costs in trading only makes it harder to come ahead.

Remember, the key at the end of the day is to ensure that your winning profitable trades outnumber your losing ones, so keeping your spread betting losses to a minimum in this way can make all the difference to your bottom line. This would offer a degree of protection against a downswing in the stock market in so far as you would gain on this spread trade offsetting the lower stock prices of your shares portfolio.

Thus, long term share investors who are concerned that the wider market is about to experience a steep fall, with consequent downside pressure on their shareholdings, could sell short an index spread bet to offset some of the risk. This is a very simple and effective way to protect the value of a diversified shares portfolio without having to liquidate the individual shareholdings. You are concerned that with the sovereign crisis engulfing Europe, your ETF portfolio might suffer a steep fall in the next few months but you prefer not to sell today for tax reasons.

However, your short spread bet is in profit and effectively cancels the loss on your tracker fund. Here you would in effect be betting a certain amount per point that the index will go lower. Of course if an investor has a shares portfolio that is more diversified than normal, then it may be feasible to make use of a beta-adjusted hedge. Beware that the FTSE is dominated by mining and oil companies so if your shares portfolio is heavily invested in other shares, the effectiveness of such a hedge will be limited.

At the time of writing June I think that one of the best hedges against long positions at the moment is the French CAC To my mind its a better short than Dow or FTSE given the the French seem intent on burying their heads in the sand and following in the path of Greece. I still retain some select company holdings and then a side-order of European shorts, with a little US indices to balance the risk to an area that is supposedly close to market neutral a lot of difficult estimates in there.

The idea being to avoid having to sell good companies rather than explicitly to make a profit, like a buffer. Do keep in mind though that while such a hedge will remove some of the downside risk, it will also effectively reduce if not eliminate any gains on your shares portfolio, so this is more of a short-term strategy and should not be utilised for long periods of time.

The hedge removes the need to have individual stop losses on your individual share positions as the premise is to ride the market turmoil keeping in mind that any losses incurred on your hedging position would be offset by gains on your shares portfolio.

Of curse this also means that you need to maintain sufficient cash reserves to maintain the hedge for as long as you believe it to be necessary. Other things to keep in mind that an index short trade might not be a good-enough hedge against the performance of the constituents making up the index and you also have to consider such things as weightings on indices, margins and cost of financing for a long term hold. You can also use spread betting to protect yourself against adverse foreign currency exchange movements.

While nobody knows exactly what is going to happen next, we can use spread betting to help minimise our exposure.

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One of the reasons that they tend to have large minimum deposits is to stop small investors, who cannot afford the risk, putting their money in. Because they are lightly regulated, they can trade in pretty much anything that they want. The Bear Sterns fund that collapsed recently was heavily into gambling on mortgage debt. Banks that had lent money to people with poor credit ratings sold the debt on.

The hedge fund borrowed money to put up with their own, and bought large amounts of this debt. When the debt started to look more shakey, and became worth a bit less, the fund collapsed, leaving nothing in it at all. A: A way to hedge a spread bet is to create an opposing bet. You can even do this with the same provider you're with, but hedging is exactly the same as being flat, except you pay a second spread and margin on the new position. Logically, it would be much cheaper to close the spread bet, and open it again if you want to 'un-hedge'.

A: Hedging rarely eliminates the risk completely, a 'perfect' hedge would effectively leave you flat in the market, except with more spread and commissions than closing your original position completely. More often, hedging is used to take out some of the risk, not all. An example of this might be buying Bund futures and selling 10 year futures simultaneously - the idea is that the two instruments are closely, but not exactly correlated.

If I believe that Bonds are going down, but the Bund it too volatile for me on its own, I can take out some of the 'volatility risk' by taking an opposite position in something that should behave in a similar way. As long as the Bund goes down more than the 10yrs as long as I make more on my short Bund trade than I lose on my Long 10yr trade , I'm in profit. This is known as an inter-commodity spread and you can do this with all sorts of things; stocks, commodities, bonds, etc You can do use a similar stratagem with multiple expiries of the same futures contract - as a general rule, contracts that expire further in the future are more volatile than the nearer dated ones - so in the example above, I could sell December Bund and hedge it with September Bund futures - if the Bund goes down as I suspect, I can expect the December future to fall more than the September one, so my profits from the December future should cover my losses on the September future, and leave me a little profit an "Intra-contract" spread.

As the two are highly correlated, this is a much less volatile position that the September future on its own. In options trading, hedging is a popular way to reduce a type of risk completely. Option prices are affected by more than just the price of the underlying e. This strategy is known as direct hedging , also commonly referred to as a perfect hedge. Whilst simple in theory, the realities of direct hedging are more complex. To protect your position against market volatility, you can choose to buy put or call options, depending on the direction of your trade.

Options can be thought of as short-term insurance policies and, as such, involve the payment of a premium. Since you pay this premium regardless of whether you close or hold on to your position, options are not a no-loss forex hedging strategy. To put it into practice, you would purchase a put option if you were long on a currency pair but had concerns that influencing factors may cause the value of the pair to fall. A put option allows you to set a strike price that is, a price at which you are willing to sell and an expiration date for the sale to be made at that strike price.

If the value was to fall, your loss would be limited to the cost of the premium to be paid to the option seller, plus the difference between the strike price and the price of the currency pair at the time you purchased the put option. This difference is measured in pips price in percentage — the unit by which profit or loss is determined in forex.

If the value moves in your favour and continues to rise, your loss would be the put option premium only. A call option is the same process applied to a short trade. So, instead of choosing a price at which you are willing to sell a currency pair, you choose a price at which you are willing to buy.

To make the most effective use of a forex hedging strategy in this way, you really need to deal in multiple currency pairs, have a sound understanding of how they correlate and, more crucially, how this relationship can offset the movement of all the currency pairs in your portfolio.

As such, this strategy is only suitable for highly experienced traders. As in any financial market, risk management is a crucial part of successful forex trading. To open a position without first considering the potential loss and how to protect yourself from it is to expose your interests to potentially devastating market volatility.

Experienced traders use a variety of techniques to cover their positions and will skilfully select which strategy to apply to any given situation. In the case of hedging, this will usually be to protect a longer-term investment from a temporary decline against their trade, simultaneously limiting potential losses to a fixed amount. This makes hedging a good alternative to a stop loss if you speculate the market will significantly favour your position in the long run.

To use a stop loss is to risk closing your trade, accepting any associated loss and eliminating your potential for future profit. Of course, you could always open a new position at a later date, if you have the capital to do so, but if your faith in the market is strong, then hedging is most likely the better option.

Ultimately, your decision on whether or not to implement a forex hedging strategy comes down to your knowledge of market swings, how confident you are in your long-term position and how much risk you are willing to expose your trade to. As discussed, a robust risk management strategy is vital to success in forex trading. Hedging, when used with skill, can help turn a potential loss into a break-even or profitable trade.

That said, hedging is not without its downsides and should be used with caution. Below are the main disadvantages of using hedging strategy protection. To implement a successful forex hedging strategy, you need to be comfortable with, and confident in, the processes involved.

If you intend to use hedging in your wider risk management strategy, you must gain experience before hedging a live trade. Demo accounts are a good place to start since they simulate a real trading environment without the need for financial investment. It, therefore, stands to reason that by mitigating risk, you also limit your chances of reward in this case, your profit.

A good forex hedging strategy is one used sparingly that protects you from a major loss in the short term, but does not excessively damage your potential for long term profit. Depending on the approach you take, your profit can be dramatically affected by a forex hedging strategy.

In the worst-case scenario, it could be wiped out completely and you could find yourself faced with a loss.

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There are several strategies used in spread betting, from trend following to news-based wagers. Other traders look to capitalize on rare arbitrage opportunities by taking multiple positions in mispriced markets and putting them back in line. Avoiding volatility risk on forex positions. For some, the allure of trading forex is that it's incredibly volatile and fast paced, but for others, there is a. A: A way to hedge a spread bet is to create an opposing bet. You can even do this with the same provider you're with, but hedging is exactly the same as being flat, except you pay a second spread and margin on the new position.