Glossary of terms
Hedging is a risk management strategy that mitigates the risk of loss due to price fluctuations by offsetting against it. It is especially common when trading instruments that experience [volatile] price movements that are heavily influenced by dynamic market conditions.
The simplest means of defining what hedging actually involves is to say that when a trader seeks to limit their exposure on a potentially volatile trade, they will open further trades that are likely to provide a profit that can be used to offset against potential losses from the riskier trade, reducing the risk to the trader of making large losses overall.
The three most common methods of hedging are to also take an opposing position, to utilise options and futures contracts and, in forex trading in particular, to place multiple currency trades.Take the Opposite Position
If a trader enters a trade in the [buy position], forecasting that the price of their chosen instrument is set to increase. They may also enter a trade in a [sell position] so that should the market turn on them, they will make a profit from their sell position, limiting their losses from the buy position.Options and Futures
An [option] gives the holder the option to buy an instrument from the seller at a predetermined price on a date in the future. [Futures] are similar to options, but rather than giving the buyer the option to trade, a futures contract makes it an obligation.
Because of their flexibility, options are the preferred method as part of a hedging strategy. Providing the trader with the opportunity to limit their exposure by only buying the option rather than the full order upfront.Multiple Currency Trades
This involves taking opposite positions on two currency pairs that are [positively correlated]. For example, the AUD/USD and the GBP/USD share a positive correlation. Therefore, a trader could take a buy position on the AUD/USD and hedge against potential losses by taking a sell position on the GBP/USD. This would mean that should there be a decline in the price of their AUD/USD position, there would also be a similar decline in the GBP/USD position. However, while they would be losing money on the AUD/USD, the would be making a profit on the GBP/USD, and subsequently, reducing their overall losses.Key Takeaways
- Hedging is a method that is used in risk management strategies as protective insurance against potential losses on riskier trades.
- Hedging serves a dual purpose and should be approached with care. As much as it protects against losses, it can also reduce possible profits.
- There are three common methods of hedging, opposing positions, options and future contracts, and multiple currency trades.
High-frequency trading,often referred to as HFT, refers to algorithmic trading undertaken by systems of powerful computers that can process extremely high volumes of transactions in milliseconds.
High-frequency trading employs computers to scan mass amounts of asset and market data across the world’s exchanges to identify sets of patterns known as algorithmics to detect and predict movement, it then utilises this data to make huge volumes of trades based on the machine’s [technical analysis].
HFT platforms perform transactions at incredible speed by placing a [limit order] to [sell] or [buy] and then earning the bid-ask spread. It has been widely viewed to be extremely disruptive in the trading of [financial instruments]as it has been known to significantly contribute to high market [volatility] in the past.
Depending on a trader’s perception, a drawback to HFT may be that the platforms rely solely on their technical analysis and do not consider any [fundamental] factors, and also do nothing to balance equal trade opportunities.
The technique of high-frequency trading was invented by Billionaire [market maker] Kyle Dennis, and quick-fire HFT became digitised in 1983 when the NASDAQ exchange introduced the first electronic form of trading.
It has since evolved to into an incredibly powerful force within the industry, with high-frequency traders earning an average of $1.92 USD in profit per transaction in 2019. It has also been recorded that in 2020, trading involving algorithms has increased to 60%.Key Takeaways
- High-frequency trading is a form of algorithmic trading undertaken by computers that scan data from across markets around the world to identify patterns and opportunities.
- The technique has been viewed as extremely disruptive and has been known to contribute to high market volatility.
- In 2020, 60% of trading involves the use of algorithms.