… but that is what the brokers will call it.
Actually, the brokers calling it hedging is a new thing in response to what has apparently become common parlance among retail traders. If you were to talk to an interbank dealer about hedging a forex position, I very seriously doubt he would think you were talking about taking a matching position in the same currency only in the opposite direction.
First, let me define hedging as most folks in the financial markets would basically call it. It is the process by which one attempts to completely or partially offset a specific risk to a position they are in.
For example, in the stock market one might take a long position in Google, but to protect against an adverse move in the general market, he would go short S&P 500 futures. By doing this he continues to have Google specific risks (bad earnings, law suit, etc.), but at least partially offsets the impact that a down turn in stocks as a whole would have on the value of his position.
Notice also that while this hedge offsets a particular risk, it also reduces the upside potential in one way or another. Being short the overall market would hinder profits in a market rally. Of course options and other strategies can be used to cap the losses suffered on the hedge, but at least some will occur. It’s like an insurance policy in that you are protected against adversity, but there’s a price.
Here’s why I don’t consider what many forex traders are doing hedging.
What happens when you go long 100,000 USD/JPY, then go short 100,000 USD/JPY? You end up with a net position of zero. No matter whether the market goes up or down, so long as you have both positions open your account will see no change in value.
Actually, that might not be totally correct. If your broker applies carry interest you’ll probably see a gradual decline in your account value because most likely the amount you pay out on the negative carry position will probably more than offset what you receive on the positive carry position.
But let’s stick strictly with the pip movement. If you were to simultaneously open a long and short position in the same pair you will automatically take a loss equivalent to the spread since you’d be buying at the offer and selling at the bid. And you would never make that money back so long as you had both positions open. Of course, if you can time it out so that your buy price is lower than your sell price, you would lock in a profit. But again, so long as both long and short trades remain open, your account value will not otherwise change.
A hedge implies that one could still profit from a position, and that the secondary transaction made minimizes the potential loss. To my mind, having a long in USD/JPY and selling an equal amount short doesn’t satisfy that criteria. Yes, the downside is protected, but there is no upside.
Of course brokers love this whole hedging thing. It creates more volume for them, which is where they make their money.