The foreign exchange market is the largest and most liquid market in the world—so high volatility is simply part of the game. For forex traders, volatility is the norm. To mitigate the currency risk that comes with every trade, different strategies can be used.

In forex trading, hedging is a method of protecting yourself from adverse market movements by strategically opening additional positions. The idea is simple: by adding one or more offsetting trades, you balance out your current exposure and reduce potential losses.

Put simply, it’s like buying yourself insurance. While this may cap your potential profits, it can also save you from sharp losses when the market turns unexpectedly. It’s all about steady wins—long-term profitable forex traders often rely on hedging to shield their positions. The goal isn’t to eliminate risk entirely (that’s impossible), but to keep risk within a known, manageable range.

Let’s walk through several forex hedging strategies, ranging from basic to more advanced ones, suitable for all levels of traders.

Strategy 1: Simple Hedging

The process of executing a forex hedge is relatively straightforward. First, you need to hold an existing position—typically a long (buy) position because you’re optimistic about the market. Then, you open a new position in the opposite direction, just in case your forecast turns out to be wrong.

This type of hedge is usually used to protect profits you’ve already made. For instance, imagine you opened a long EUR/USD position when the exchange rate was 1.10, expecting the dollar to strengthen. A few days later, the rate climbs to 1.15—you’re in a good profit zone.

To safeguard these gains, you open a short (sell) position of the same size at 1.15. If the rate continues to rise, your long position keeps profiting, and while your short loses, the net result is still positive. If the rate drops back to 1.12, your short position gains, offsetting some of the losses in the long trade—thus protecting your prior gains.

You might ask: why not just close the trade at 1.15 and lock in the profit? That’s valid—the net result may be similar. But hedging allows you to stay in the market and watch how things unfold, giving you the flexibility to adjust your strategy. Your profit is locked in, and you can react more dynamically than if you simply exited the position.

Strategy 2: Options Hedging

Forex options allow the buyer to exchange a currency pair at a specified price before the contract expires. Options are a popular hedging tool because they offer risk protection while only requiring the payment of a premium.

Let’s say you hold a long AUD/USD position, entered at $0.56. You expect a potential market downturn, so you buy a put option at $0.55, valid for one month.

If the market falls below $0.55 by expiration, your long position will lose money—but your put option will gain value, offsetting the loss. If AUD/USD rises instead, the option simply expires worthless, and your only cost is the premium (your “insurance”).

You can also hedge using CFDs (Contracts for Difference), which work similarly to options in concept and execution. We won’t go into CFDs in detail here, as the logic is largely the same.

The example above illustrates a basic options hedge. Now let’s look at something a bit more complex.

Strategy 3: Multi-Currency Hedging (Perfect Hedge)

The multi-currency hedging strategy, also known as a perfect hedge, involves opening opposing positions in two positively correlated currency pairs—such as AUD/CAD and EUR/GBP.

Let’s first explain the correlation between these pairs:

  • AUD (Australian Dollar) and CAD (Canadian Dollar) are both commodity currencies. Their value is tied to commodity prices like oil and minerals. When commodity prices rise, both tend to strengthen—so the AUD/CAD pair is influenced by the broader commodity market.
  • EUR (Euro) and GBP (British Pound) are both shaped by the relative economic performance of the Eurozone and the UK. If the Eurozone is doing well while the UK economy lags, the euro may strengthen relative to the pound, and vice versa. Their correlation varies over time but often reflects regional macroeconomic trends.

Now imagine a trader holds a short EUR/GBP position (expecting the euro to fall and the pound to rise). To hedge this, they simultaneously open a long EUR/GBP position (expecting the opposite). Meanwhile, they might also hold a long AUD/CAD position.

If the euro weakens against the dollar, the AUD/CAD long may lose money—but this loss could be offset by gains in the EUR/GBP hedge. Conversely, if the pound weakens, the hedge can help balance out losses on the short side.

This type of strategy is very complex and relies on a deep understanding of inter-currency correlations. It carries a high risk of misjudgment and is not recommended for beginners.