When hedging with CFDs, buying and selling the same financial instrument, don't you end up earning nothing respectively losing because of the spread?

  • 2
    You wouldn't buy and sell the same exact one.
    – quid
    Apr 17 '17 at 21:14
  • @quid But then you would have to know which one will fall and which one will rise. Which would render the whole concept of hedging useless. Apr 17 '17 at 21:17
  • 2
    @VitalisHommel If you knew that would be arbitrage. Hedging offsets an existing position by making a trade in the opposite direction.
    – D Stanley
    Apr 17 '17 at 21:20
  • 2
    The function of a hedge is to place a limit on your risk. You determine how much you'd be willing to risk and set your positions accordingly. As DStanley points out, buying and selling the same thing at a profit is called arbitrage, and true arbitrage opportunities are very few and far between.
    – quid
    Apr 17 '17 at 21:21
  • @DStanley "making a trade in the opposite direction." Which gives you zero at best roi. Apr 18 '17 at 6:45

I think you're misunderstanding the purpose of CFDs and hedging. When you use a CFD for hedging, you're not buying and selling the same instrument, you're using one instrument to offset risk in another.

Suppose you're a German manufacturer and have a large order from a Russian customer, who can only pay in Rubles when the order is delivered in 9 months. You are a manufacturer, not a bank, so you have no idea what the exchange rate between the Euro and Ruble will be in 9 months, but you are satisfied with the terms given the current exchange rate.

You talk to your bank, who offers to use a Contract For Difference to protect you from fluctuations in the exchange rate in 9 months. If the exchange rate goes up (meaning your rubles are worth less) the bank will compensate you for the difference, and vice versa.

So your "hedge" just reduces your exposure to the RUB/EUR exchange rate - you still made money on the actual sale, but don't have exchange risk now.

Hedging is not about profiting, it's about managing risk. Sure the exchange rate could have moved in your favor and you'd have made even more money, but it's just as likely that you'd have lost money, possibly to the point where the entire deal would have been unprofitable.

  • Interesting. How does this apply to daytrading when traders never intend to buy or deliver real goods? What do you hedge in the case of a daytrader? Apr 18 '17 at 14:53
  • That's not hedging - that's offsetting positions to lock in profit (or cap loss). Hedging is about reducing risk, not profiting.
    – D Stanley
    Apr 18 '17 at 15:01
  • In other words, daytraders cannot hedge? Apr 18 '17 at 15:02
  • 1
    Can they? I suppose, but that's not the goal. A daytrader's goal is to take a position and exit it within the same day in order to make a profit. If a daytrader takes offsetting positions that make a profit, that's arbitrage, not hedging. Hedging is about reducing risk in the long run (hedges often lose money).
    – D Stanley
    Apr 18 '17 at 15:07

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