Hedge: Friend or Foe?!? | Forex Factory

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Hedge: Friend or Foe?!?

  • #1
  • First Post: Jul 12, 2007 6:03am Jul 12, 2007 6:03am
Hedge is one of the important techniques in forex. Thus, I feel it is useful to discuss it

There are different types of hedge:

1. Professional Hedge: When buying (or selling) two different pairs containing a single unit; e.g., EUR/USD and USD/JPY. This kind of hedge strongly needs fundamental analysis.

2. Common Hedge: When you buy (or sell) a single pair at the same time.

3. Urgent Hedge: When something is wrong with your order and you are losing more and more, you will open a position on inverse direction to avoid more loss and probably ending up your margin.

4. Long Hedge: When you keep a lost order for long time for the hope of retuning the market to the price you started (sometimes wise and sometimes stubborn); during this time you may wish to trade on the inverse direction only due to good opportunity, not the essence of hedge.


Could you please discuss these different types here, and why brokers hate hedge? [1]


[1] Brokers usually hate the second type of hedge, and do not allow traders to do this. But the software cannot recognize the type and will not allow you to do so in other cases. In some cases, it may lead you to significant losses. For this reason, I strongly recommend not to use brokers (even famous ones) not allowing hedge.
  • #2
  • Jul 12, 2007 7:09am Jul 12, 2007 7:09am
Guess I would classify 2-4 as simply dumb "hedges" for which there is generally no point. 1) on the other hand is just standard trading.

In a true hedge you should be looking for a position in one set of intruments to make a profit while using another set to lower your risk.

As for 2) in particular - are you talking about buying and selling a single pair at the same time? If so, the reson most FX dealers have avoided it in the past is because that's the way one used to close trades. They love it now because they get the spread in both directions, and carry no immediate risk. In other words, you've paid to be flat...
  • #3
  • Jul 12, 2007 7:20am Jul 12, 2007 7:20am
Yes you are right,

Common Hedge is a silly way in forex, and brokers hate this and because of this they avoid hedge.
  • #4
  • Jul 12, 2007 7:33am Jul 12, 2007 7:33am
how about 2 directional grid?
  • #5
  • Jul 12, 2007 7:46am Jul 12, 2007 7:46am
Quoting Gwan
how about 2 directional grid?
what do you mean by two directional grid ?
  • #6
  • Jul 12, 2007 9:19am Jul 12, 2007 9:19am
Where would one find a calculator to determine the optimal lot positions to neutralize the movement as described in example 1?
  • #7
  • Jul 12, 2007 9:33am Jul 12, 2007 9:33am
Quoting lcfxtrader
Where would one find a calculator to determine the optimal lot positions to neutralize the movement as described in example 1?
It just depends on your fundamental analysis

In fact, you should choose stable curencies as they are not highly altered, then you can be sure that the changes of the pair is mainly due to your joint currency

For instance, these days, major changes are due to the change in USD. Thus, if you choose two pairs containing USD the main changes on opposite directions can compensate each other
  • #8
  • Jul 12, 2007 10:03am Jul 12, 2007 10:03am
Hedge trades are like a double-edge sword that cuts both ways. I have succeeded on some hedges and been burnt on others.

The only hedge that might have some merit is what you called a "professional hedge."

When you make a bad trade, just admit it and move on.

I think that some brokers do like some hedging because they win if you exit it the wrong way.
  • #9
  • Jul 12, 2007 10:09am Jul 12, 2007 10:09am
You are right

One should practice to learn applicable professional hedge

I did not see a broker encounraging the traders for hedge


Quoting KudzuFX
Hedge trades are like a double-edge sword that cuts both ways. I have succeeded on some hedges and been burnt on others.

The only hedge that might have some merit is what you called a "professional hedge."

When you make a bad trade, just admit it and move on.

I think that some brokers do like some hedging because they win if you exit it the wrong way.
  • #10
  • Jul 12, 2007 6:25pm Jul 12, 2007 6:25pm
Quoting etrade
Hedge is one of the important techniques in forex. Thus, I feel it is useful to discuss it

There are different types of hedge:

1. Professional Hedge: When buying (or selling) two different pairs containing a single unit; e.g., EUR/USD and USD/JPY. This kind of hedge strongly needs fundamental analysis.

2. Common Hedge: When you buy (or sell) a single pair at the same time.

3. Urgent Hedge: When something is wrong with your order and you are losing more and more, you will open a position on inverse direction to avoid more loss and probably ending up your margin.

4. Long Hedge: When you keep a lost order for long time for the hope of retuning the market to the price you started (sometimes wise and sometimes stubborn); during this time you may wish to trade on the inverse direction only due to good opportunity, not the essence of hedge.


Could you please discuss these different types here, and why brokers hate hedge? [1]


[1] Brokers usually hate the second type of hedge, and do not allow traders to do this. But the software cannot recognize the type and will not allow you to do so in other cases. In some cases, it may lead you to significant losses. For this reason, I strongly recommend not to use brokers (even famous ones) not allowing hedge.
1 is not hedging. If you are deliberately trying to cancel out the USD part of two pairs then it is a synthetic pair and it is normally cheaper to trade the cross directly.

2 is not hedging. If your net position is zero then you are out of the market and it is impossible for you to make any profit. Some brokers have started allowing clients to hold open orders that cancel each other out. They even take margin for these zero positions and charge interest on rollover. This is free money for the broker. These brokers are not your friends.

3 is something you might do if you can't get a close order to your primary broker for some reason. You could open a reverse position with your backup broker. This is a valid hedge in an emergency.

4 is the same as 2, i.e. nonsense.
  • #11
  • Jul 12, 2007 7:19pm Jul 12, 2007 7:19pm
It has probably been discussed before but here's my idea:

Long 20 lots on GBP/JPY at 400:1 with $250 margin for every lot
Short XX lots on CHF/JPY at 400:1 with $250 margin for every lot

Short position number of lots should be enough to neutralize the long. Let's use 40 lots as an example:

20 X 250 = $5000 margin requirement to open position
40 x 250 = $10000 margin requirement to open position

Buy swap is 24.30 per lot x 20 lots = $486 daily
Sell swap is -5.99 per lot x 40 lots = -$239.60 daily

Daily profit from swap = $486 - $239.60 = $246.40
Weekly profit from swap = $246.40 x 7 days = $1724.80

The spread would need to be covered before account is positive. How does one determine the number of lots to short? Would my above example work? Please provide any helpful feedback. Thanks
  • #12
  • Jul 13, 2007 9:25am Jul 13, 2007 9:25am
Quoting lcfxtrader
It has probably been discussed before but here's my idea:

Long 20 lots on GBP/JPY at 400:1 with $250 margin for every lot
Short XX lots on CHF/JPY at 400:1 with $250 margin for every lot

Short position number of lots should be enough to neutralize the long. Let's use 40 lots as an example:

20 X 250 = $5000 margin requirement to open position
40 x 250 = $10000 margin requirement to open position

Buy swap is 24.30 per lot x 20 lots = $486 daily
Sell swap is -5.99 per lot x 40 lots = -$239.60 daily

Daily profit from swap = $486 - $239.60 = $246.40
Weekly profit from swap = $246.40 x 7 days = $1724.80

The spread would need to be covered before account is positive. How does one determine the number of lots to short? Would my above example work? Please provide any helpful feedback. Thanks
nice point about the role of swap on hedge

Thanks for sharing with us
  • #13
  • Jul 13, 2007 9:36am Jul 13, 2007 9:36am
A hedge is nothing more than a hedge. It's how you deal with it that counts
  • #14
  • Jul 13, 2007 5:05pm Jul 13, 2007 5:05pm
Quoting lcfxtrader
It has probably been discussed before but here's my idea:

Long 20 lots on GBP/JPY at 400:1 with $250 margin for every lot
Short XX lots on CHF/JPY at 400:1 with $250 margin for every lot

Short position number of lots should be enough to neutralize the long. Let's use 40 lots as an example:

20 X 250 = $5000 margin requirement to open position
40 x 250 = $10000 margin requirement to open position

Buy swap is 24.30 per lot x 20 lots = $486 daily
Sell swap is -5.99 per lot x 40 lots = -$239.60 daily

Daily profit from swap = $486 - $239.60 = $246.40
Weekly profit from swap = $246.40 x 7 days = $1724.80

The spread would need to be covered before account is positive. How does one determine the number of lots to short? Would my above example work? Please provide any helpful feedback. Thanks

Based on current Prices, if you want to hedge that Long 20 lots GBPJPY, you will need Short 48.9 lots CHFJPY.

Swap wise, you will be earning:
20lots x $24.30 daily = $486.00
48.9lots x -5.99 daily = $292.91
Net Swap= 193.09 Nice eh?

But these two positions is exactly equivalent to Long 20Lots GBPCHF which nets a daily swap of $16.75 per lot for a total of $335...

And if CHF gain strength vs GBP, you will wipe your account dry in hours.
  • #15
  • Jul 13, 2007 5:52pm Jul 13, 2007 5:52pm
BK,

Can you please show the calculations to determine the lot size for the short position taken? I started a demo account last night with a $25K starting balance with the following positions:

Buy GBP/JPY - 20 lots
Sell CHF/JPY - 36 lots

Swap balance for today = $270.36
Margin to open all positions = $14K
Free margin = $11694.47
Margin level = 183.53%
Equity = $25694.47
Positions will be closed at 100% margin level per broker requirement.

Thanks
  • #16
  • Jul 13, 2007 7:06pm Jul 13, 2007 7:06pm
Quoting lcfxtrader
BK,

Can you please show the calculations to determine the lot size for the short position taken? I started a demo account last night with a $25K starting balance with the following positions:

Buy GBP/JPY - 20 lots
Sell CHF/JPY - 36 lots

Swap balance for today = $270.36
Margin to open all positions = $14K
Free margin = $11694.47
Margin level = 183.53%
Equity = $25694.47
Positions will be closed at 100% margin level per broker requirement.

Thanks
Your position is roughly equivalent to 15 lots long GBP/CHF + 5 lots long GBP/JPY. This would make you more money for the same risk simply by eliminating the hedged portion. The hedged portion is only making money for the broker.
  • #17
  • Jul 13, 2007 9:31pm Jul 13, 2007 9:31pm
Please explain how you derive to this theory?
  • #18
  • Jul 13, 2007 11:56pm Jul 13, 2007 11:56pm
Quoting etrade
what do you mean by two directional grid ?
now that i think about it, it is number 4 in range market

Quote
4. Long Hedge: When you keep a lost order for long time for the hope of retuning the market to the price you started (sometimes wise and sometimes stubborn); during this time you may wish to trade on the inverse direction only due to good opportunity, not the essence of hedge.

  • #19
  • Edited 12:23am Jul 14, 2007 12:11am | Edited 12:23am
There are so many ways to hedge indirectly and I will show you how to compute it mathematically:

Given current prices:
GBPJPY = 248.02
CHFJPY = 101.37
GBPCHF = 2.4461
GBPCHF 200 days MA = 2.4070


1. Current Price Hedging for GBPJPY and CHFJPY

Buy GBPJPY is exactly Buy 100K GBP and Sell 24.802M JPY
Sell CHFJPY is exactly Sell 100K CHF and Buy 10.137M JPY
Looking above, you will see that there is an inbalance in the 3 currencies. You may either want it that way (ie, having a very inbalanced basket), or you may want to simplify it by eliminating a currency. For all intense and purposes, I pick to eliminate JPY currency.

To eliminate JPY from the hedge, I need to Buy 24.802M JPY; if I do so, I then need to sell (24.802/10.137) 2.4466 Lots of CHFJPY. Isnt it magical that 2.4466 is very near the current price of GBPCHF? Its not magical; its reality. The small discrepancy of 5 pips is from the spread! If you are very comfortable computing this way, you can find price inefficiency (aka arbitrage) such that, you can spot a wrong price and buy/sell for sure 100% profit.

This hedge is best if GBPCHF is perceived to be going higher than 2.4466 (ie, bullish) as this hedge assumes GBPCHF is bullish. (I already stated that in my last post).

2. Average Price Hedging
A simpler method is with the use of Moving Average. Get the most stable price of GBPCHF; I pick the 200 Days MA which is currently at 2.4070.

Simply put, To hedge a Buy 1Lot GBPJPY, you need to sell 2.41 Lots of CHFJPY.

This hedge is best if GBPCHF is currently under the 200 Day MA and is perceived to be going up anytime soon. OR if GBPCHF is continuing to go even higher than the 200 MA (if it is above like it is currently)...


Take your Pick. but both are dependent on the bullishness of GBPCHF. If you want to do this hedge, always note to do so when GBPCHF has made a dip. ie, plot RSI and bollinger band. if the daily price touched below the band and RSI is below 30, then its good to go.

Remember, this is not a perfect hedge and if GBPCHF continues south, your account will be wiped clean.
  • #20
  • Last Post: Jul 14, 2007 9:02am Jul 14, 2007 9:02am
Quoting lcfxtrader
BK,

Can you please show the calculations to determine the lot size for the short position taken? I started a demo account last night with a $25K starting balance with the following positions:

Buy GBP/JPY - 20 lots
Sell CHF/JPY - 36 lots

Swap balance for today = $270.36
Margin to open all positions = $14K
Free margin = $11694.47
Margin level = 183.53%
Equity = $25694.47
Positions will be closed at 100% margin level per broker requirement.

Thanks

Yes it is very important point

Contrary to hedge of a specified pair, hedging two pairs is difficult. In the first case, sell and buy orders will always cover each other to avoid lack of margin, but in the latter case, a careful attention should be paid to the margin. Sufficient margin should be used.
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