The structure of the forex market

 in which we are able to take position of $100,000 with an initial deposit amount of $1000.

This $1000 deposit amount is called “margin” you had to give in order to initiate a trade and use leverage.

Your broker to maintain your position uses it. The broker collects margin money from each of its client (customer) and uses this “super margin deposit” to be able to place trades within the interbank network.

Margin is expressed as a percentage of the full amount of the position. Your margin may vary from 10% to .25% margin. Based on the margin required by your broker, you can calculate the maximum leverage you can yield with your trading account.

For example, if your broker required 5% margin, you have the leverage of 20:1 and if your margin is 0.25%, you can have leverage of 400:1.

Hedging

Hedging is basically a strategy which is intended to reduce possible risks in case prices movement against your trade. We can think of it with something like “insurance policy” which protects us from particular risk (consider your trade here).

To protect against a loss from a price fluctuation in future, you usually open an offsetting position in a related security. Traders and investors usually use hedging when they are not sure which way the market will be heading. Ideally, hedging reduces risks to almost zero, and you end up paying only the broker’s fee.

A trader can utilize hedging in the following two ways −

To open a position in an off-setting instrument

The offsetting instrument is a related security to your initial position. This allows you to offset some of the potential risks of your position while not depriving you of your profit potential completely. One of the classic example would be to go long say an airline company and simultaneously going long on crude oil. As these two sector are inversely related, a rise in crude oil prices will likely cause your airline long position to suffer some losses but your crude oil long helps offset part or all of that loss. If the oil prices remain steady, you may profit from the airline long while breaking even on your oil position. If the prices of oil goes down, the oil long will give you losses but the airline stock will probably rise and mitigate some or all your losses. So hedging helps to eliminate not all but some of your risks while trading.

To buy and/or sell derivative (future/forward/option) of some sort in order to reduce your portfolio’s risk as well as reward exposure, as opposed to liquidating some of your current positions. This strategy may come handy where you do not want to directly trade with your portfolio for a while due to some market risks or uncertainties, but you rather not liquidate part or all of it for other reasons. In this type of hedging, the hedge is straightforward and can be calculated precisely.

Stop Losses

A stop-loss is an order placed in your trading terminal to sell a security when it reaches a specific price. The primary goal of a stop loss is to mitigate an investor’s loss on a position in a security (Equity, FX, etc.). It is commonly used with a long position but can be applied and is equally profitable for a short position. It comes very handy when you are not able to watch the position.

Stop-losses in Forex is very important for many reasons. One of the main reason that stands out is no one can predict the future of the forex market every time correctly. The future prices are unknown to the market and every trade entered is a risk.

Forex traders can set stops at one fixed price with an expectation of allocating the stoploss and wait until the trade hits the stop or limit price.

Stop-loss not only helps you in reducing your loss (in case trade goes against your bet) but also helps in protecting your profit (in case trade goes with the trend). For example, the current USD/INR rate is 66.25 and there is an announcement by the US federal chairperson on whether there will be a rate hike or not. You expect there will be a lot of volatility and USD will rise. Therefore, you buy the future of USD/INR at 66.25. Announcement comes and USD starts falling and suppose you have put the stop-loss at 66.05 and USD falls to 65.5; thus, avoiding you from further loss (stop-loss hit at 66.05). Inversely in case USD starts climbing after the announcement, and USD/INR hit 67.25. To protect your profit you can set stop-loss at 67.05(assume). If your stop-loss hit at 67.05(assume), you make profit else, you can increase your stop-loss and make more profit until your stop-losses hit.

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