In a hedging system, a trader can maintain several open trades for the same trading instrument simultaneously. Each trade exists as a separate entity.
How it works: If a trader buys 1 lot of SFX Vol 99 and then buys another 2 lots, two distinct positions appear in the terminal.
Closing trades: To exit their market exposure, the trader must manually close each of these trades individually.
Special features:
Directional independence: A trader can hold "buy" and "sell" positions for the same instrument at once.
How netting works?
Netting system restricts a trader to only one open position per instrument. All subsequent actions for that instrument are "netted" into the existing position.
How it works: If a trader buys 0.01 lot of SFX Vol 99 and then adds 0.01 more and 0.1 lot more, the terminal will show a single position of 0.12 lot. Note, the opening price of this total position will be calculated and not just taken from one of the trades a trader just made.
This is what the trader was doing:
And this is his total position in the end:
Note, that the final open price of that total position is not just the average of all prices of all deals made - it’s a volume weighted average price. It’s important to understand that it’s calculated and there might not have been such a price in the price feed.
Closing trades: If that same trader then sells 0.12 lots of SFX Vol 99, the entire position gets closed because the net result is zero.
Special features:
Partial closing: If a trader has 3 lots of SFX Vol 99 and then sells only 1 (out of 3), he’ll receive the remaining position of 2 lots of and trading result for closing 1 lot SFX Vol 99.
Trades reversal: If a trader has 1 lot of SFX Vol 99 and is long - in the netting system it’s possible to go from long to short in one go only. What the trader has to do is sell more volume than he has now, for example, 4 lots. In this case he’ll receive a new (short) position of 3 lots and a trading result for closing 1 lot. In hedging the trader would have to close his long position first (at the current market price) and then open a new position (at the current market price).
Where did netting come from?
The concept of netting originates from the banking industry. Its core feature is offsetting. It is the process of regularly paying mutual obligations by calculating the difference between them.
Simple offsetting example: If Person A owes Person B $100, but Person B owes Person A $90, the debt is "offset" so that Person A simply owes Person B $10.
Does it sound familiar?
In a trading terminal, this means your total position is updated every time you add or subtract volume. Unlike hedging, where "buy" and "sell" orders stay separate, netting offsets them immediately to show your true market exposure.
Frequently asked questions (FAQs)
What is hedging in trading?
What is hedging in trading?
Hedging in trading is a strategy used to reduce potential losses by opening an additional position that offsets the risk of an existing trade. Traders use hedging to manage exposure to market fluctuations.
How does hedging work in Forex?
How does hedging work in Forex?
Hedging in Forex works by opening positions that reduce the risk of adverse price movements. For example, a trader may open an opposite position or use related instruments to offset potential losses.
Why do traders use hedging strategies?
Why do traders use hedging strategies?
Traders use hedging strategies to protect their positions from unexpected market movements and to manage risk more effectively in volatile market conditions.
Can hedging reduce trading risk?
Can hedging reduce trading risk?
Yes, hedging can help reduce trading risk by limiting potential losses when the market moves against an open position. However, it may also reduce potential profits.
What is an example of hedging in trading?
What is an example of hedging in trading?
An example of hedging is when a trader opens a buy position on a currency pair and then opens a sell position to offset potential losses if the market moves in the opposite direction.
Is hedging allowed in Forex trading?
Is hedging allowed in Forex trading?
Hedging is allowed by some brokers and trading platforms, depending on their trading conditions and regulations. Traders should review their broker’s policies before using hedging strategies.