It's say you take a long position is EUR/USD at 1.2700. The price drops. With a different broker, you take a short position at 1.2650. Have you hedged your long?
I've met traders who say yes. They say that now there short will make what every there long position loses.
I hate to burst bubbles, but going long and short is going flat. It's the same as having no position on. The only difference is you'll pay the spread twice (a bad thing).
The traders who say that going long and going short is hedging say that when the price moves up they will take the short position off to capture the upward movement are still deluded.
Having a short and long position in the same instrument, and then taking the short one off, is the same as just entering long. That's it. Furthermore, how do you know that the market will continue to move up after you take the short off? If it moves down again will you put the short on again? If you do, you will pay the spread a third time for a single trade. Believe, make this a habit and you find being profitable is tough even if you pick more winners than losers and have great money management.
So, let's take this is a different direction. What if you traded EUR/USD long and went short USD/CHF? Have you hedged against the dollar? No. What you've done is created the currency pair EUR/CHF with two other pairs. You're not hedged; you're long EUR/CHF.
So how do you create a true hedge with currencies? You have two tools to use. One way would be with futures. The next subsection deals with the other. The CME has an emini Euro FX contract (symbol is E7). You could be long in the spot market and short in the futures market and you would be hedged. However, the futures contract and a spot contract are not worth exactly the same; so you would not be totally covered.
The last way to hedge is with options. This is also how you can trade without stops safely. Let's say you go long USD/JPY at 116.00. You also go long a put option out of the money with a strike price at 115.50. Let's say it cost you $20.
The price must go up 20 pips (in a mini account) for you break even. You lose the cost of the option if the price doesn't sink below 115.50. If the price does plunge down to 114 say, your put options will be worth a lot. Subtracting what you made on the options from what you lost on your position, you'd find that you only lost 70 pips (the cost of the option $20 plus the difference between your entry and the strike price $50).
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