How to Trade Gold as a Hedging Tool

ByCaesar Reading Time: 3 minutes

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As per CBS News, the value of gold has increased by more than 90% over the last five years, and there are no signs it will come down anytime soon.

Let’s take a closer look at what makes gold a hedging tool and how you can trade gold effectively.

What Makes Gold a Safe Haven

When inflation rises and the value of fiat money goes down, gold emerges as a safe haven. Gold preserves its purchasing power, unlike stocks and bonds. 

Moreover, gold and the USD typically have an inverse relationship, which means that when the dollar weakens, gold prices increase, and vice versa. Trading XAU/USD can help maintain balance and ensure protection in case of economic instability. 

Another common reason why gold is considered a hedging tool is the lack of counterparty risk. No institution or government can manipulate prices, ensuring peace of mind for traders and investors alike. 

Ways to Trade Gold for Hedging

So, how can you actually use this precious metal for hedging? Here are some gold trading options:

Physical Gold

Trading physical gold in the form of bars, coins, and bullion is pretty common. While it helps you build wealth over time, it is not ideal for quick trades. 

Gold ETFs

With gold Exchange-Traded Funds (ETFs), you can enter the market without worrying about the physical commodity. ETFs track the price of gold and can be bought or sold on stock exchanges just like regular stocks. 

Gold Futures Contracts

Gold futures contracts allow you to lock in a price for future delivery of gold. As a result, you have the option (not the obligation) to buy or sell gold at a specific price. With gold futures contracts, you can hedge against unfavourable price spikes.

Gold Mining Stocks

This involves investing in gold mining companies and gaining profits when gold prices increase. But keep in mind that your profit amount heavily depends on the company’s performance.

When to Use Gold as a Hedge

While there is no one-size-fits-all approach, there are some situations where gold shines best as a hedging tool. Here are some examples:

  • Inflationary periods
  • Economic instability
  • Geopolitical tensions, such as wars and trade disputes
  • Currency devaluation, especially when the dollar drops

Gold can also be used as a hedge if you’re trying to diversify a highly stock-dependent portfolio. 

Tips to Trade Effectively as a Hedge

Without precautions, gold trading can turn into a nightmare. Here are some key tips:

  • Know what you’re hedging against, be it inflation, economic crisis, or currency devaluation.
  • Start with a small allocation. Avoid putting all your capital in gold assets. A 5-10% allocation is considered appropriate. 
  • Avoid emotional trading. Practice mental discipline, stick to your long-term strategy, and use a trading journal to make informed decisions.
  • Consider correlation. Explore how different assets correlate with gold. This can help you manage risks and ensure balance. 

Gold can be an effective hedging tool if you practice appropriate risk allocation and adapt to changing market conditions. 

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