PHE's journal

Hi friends. I've decided to start a journal. Here we go:

The greatest thing I have learned about trading is this: You can not know where the market will go.

That's not some negative-Nancy (or Debbie-downer, if you prefer ) talk like you'll hear some people saying about the impossibility of trading successfully. That talk is nonsense. Lord willing, I will never return to corporate employment life again since my trading business is moving along so well. So "you can't be successful", is not what I am saying at all. Trading is a business like any other, and recognizing supply and demand can be profitable, as with most any other types of businesses.

The point is, people spend so much time trying to predict what the market is going to do, instead of learning to react to what the market has already done. That is a BIG difference. If you recognize the truth of what I have said, that you can't know where the market is headed, then you can spend your time wisely.

Simple as this may seem, if you learn and apply this wisdom to your own trading, you will see what a powerful realization it actually is.

Good trading to you, and God bless you.

Your friend,
-PHE

Seems like there's been some recent talk about "hedging" again lately. In FX trading, when people say hedging, they typically mean being long and short the same ccy pair. This is different than a more traditional hedge in investing, but that's not what I intend to write about here.

With this "FX hedge", being simultaneously long and short a particular pair, there are some immutable facts to consider:

You are flat (or nearly flat, depending on entry), the market.
You will not gain nor incur any capital from swap should you hold the positions during rollover.

Now, we tread into the less immutable, yet still factual matters. Some will say that this is unwise because you are paying double spread for the position, yet this may not be the case. If you are halving the position for the sake of creating an "FX Hedge", you aren't subject to any more spread than you would have been by taking a full size position. Others will make a similar argument about commission, yet, if you have halved the position, what I've said about the spread applies here as well.

So since the purpose of trading is to make money, and since thus far we haven't seen any any benefit of doing an FX Hedge, why do it?

Folks that talk of the benefit of running an FX Hedge will say that there are successful systems that do so. Assuming that is true, the key consideration becomes: Why? Why do these hedge systems work, with all the above information known?

Any rule based system, whether is is manually executed, or mechanically managed, is based on immovable rules. Even systems which contain dynamic adjustments still make those adjustments based on some rule set. Let's keep it simple though:

1. Enter the hedge
2. Signal condition met, exit one side of the hedge
3. Manage remaining position

Now since we have said that a FX Hedge is essentially flat the market, and since we have also said that signals are responsible for the entrance into the hedge, the exit of half, and the exit of remaining, there is a better way to trade such systems, while reducing your market exposure. If you simply note (technically or otherwise) where the initial hedge signal would have been, yet refrain from market entry until signal 2 where the hedge direction determination signal presents, you have limited your market exposure, and you can still achieve the same goal as desired in step 3. In fact if you have managed your risk based on the 3rd stage of a hedge trade, you can trade HALF the size you would have entered in step 1, since the result in step 3 is the same. In one sense you limit your risk as well by exposing less of your capital.

One final thought is what this sort of trading style gives you that you CANNOT put on paper as I have above: comfort. This sort of trading gives a trader emotional comfort as the trader reasons that they now "know more accurately" the direction of the market. It gives a sense of acting cautiously with trading, and caution is good, right? It gives the sense of "doing something" during phase 1 of the hedge, since you're actually "in the market", instead of just thinking about being in. "Doing something" is good, right?

Unfortunately caution doesn't pay any bills. Abandon doesn't either. In fact, none of your emotions will. But as I've shown above, the technical difference of taking signals from a hedging system without actually placing the hedge, is mute. And as I've argued, you may even see it as a superior way to trade that system, based on the potential exposure / risk reduction.

These are some thoughts for you to consider, but as always:
Everything you do is at your own risk. Do wisely!