Hedging has been used as a strategy in various forms of trading for a number of years now, and can currently also be used by those who trade binary options. The general strategy will vary along with the form of investment, but the goal remains the same – to limit risk while earning more money. This common goal is shared by all who wish to profit from asset price movement.
With regards to binary options specifically, hedging is often referred to as straddling. This term is derived from an old saying about being on both sides of a fence at the same time. When trading, it means to cover two different sides of a trade. This can be done either simultaneously, over over a longer period of time, depending on the expiry time that is chosen.
Short-term hedging generally involves purchasing two contracts at, or near the same time. These contracts will match, which may sound crazy, but read on before drawing conclusions. When two matching contracts are purchased, one will be a winner and one will go into the loss category. In order for this strategy to be profitable, the profits gained from the winning trade must cover the loss sustained on the losing trade and still provide some amount of profit.
In modern binary options platforms, this is not always easy to accomplish when opting for standard trade types when the same investment amount is chosen for both trades. For example, if the payout rate is 75%, and $100 is committed to each trade, the total return would be $175 (one win, one loss). Since the total cost for both trades would be $200, a total of $25 would be lost. The payout rate would need to exceed 100% in order for this strategy to work correctly.
So, what is the alternative? That would be to invest a larger amount to the side of the trade that analysis has shown is more likely to be the winner. Should your forecast be correct, and you’ve done the math to determine that a profit is possible, money will be earned. Should the forecast be incorrect, the larger amount will be lost. However, the total loss will be minimized by the earnings that come from the trade with the lower investment amount.
There is similar strategy to consider, and this would be to select the same asset and investment amount, but select different expiry times. Here, there is the option to use the same selection, Put or Call, or use opposing selections should you feel that a retraction is likely. The risk with this type of binary options strategy is quite clear. Both trades could end in a loss. On the other hand, both could be winners and double the profit will be earned.
Long-term hedging is quite different, and tends to be simpler. In fact, it is actually more of a money management strategy than anything else. This method involves setting up long-term trades that will expire several weeks, or even several months from the purchase date. The goal would be to receive a boost to account funds via controlled investing. Fast trading is all the rage with binary options traders, but some consideration can and should be given to other expiry times as well.
In general, hedging is most often viewed as a profit generator. However, it should also be viewed as a means of reducing risk. There are several different methods which can be used, some of which are appropriate for beginners, and some of which are best used by traders with at least some experience. As a binary options strategy, fundamental hedging should be viewed as a proven method of keeping risk to a minimum, while enjoying the profits that come from making educated investment decisions.