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hedging one currency pair with another

  • #21
  • Feb 26, 2008 3:13pm Feb 26, 2008 3:13pm
oops, i just realized i used a "+" instead of a "*". i need to sharpen my math skills!

thanks for catching that capitalist!
Relax and be happy.
  • #22
  • Feb 26, 2008 3:18pm Feb 26, 2008 3:18pm
Quoting merlin
oops, i just realized i used a "+" instead of a "*". i need to sharpen my math skills!

thanks for catching that capitalist!
  • #23
  • Mar 21, 2008 10:35pm Mar 21, 2008 10:35pm
The crucial concept of hedging is understanding exactly what risk you're hedging against.

In the buy EUR/USD buy USD/CHF example, merlin is right that you are simply buying a EUR/CHF position. On the other hand, forexlion and daytrading are also right: by essentially entering into a EUR/CHF position, you're hedging against USD risk. You are not hedging against either EUR or CHF risk, however. In fact, the whole point of taking a EUR/CHF position is to assume the risk of both EUR and CHF with the expectation that it will provide some reward.

There are ways to hedge risk cross-market with a positive expectancy when certain inefficiencies exist. Below is an example:

Assuming the GBP/JPY is strongly correlated with the US equity markets, one could buy GBP/JPY and sell S&P futures with appropriate sizing such that a move up in the S&P would lose just as much as the GBP/JPY wins. The GBP/JPY position would be earning the interest-rate differential, however, giving a positive expectancy earning. Assuming one could have strong leverage in both contracts, the return on initial investment could be quite attractive with low risk. Of course, if the correlation btw GBP/JPY and the S&P falls apart, you are exposed to more risk than expected, but this change in correlation could occur in either direction, so the hedge is still positive expectancy.

I'm no expert, but I think this is correct. Can anybody find a hole in my argument? It's late on a Friday after exams week, so I could be totally wrong...

Any other interesting hedging opportunities you can think of?
  • #24
  • Mar 27, 2008 1:51pm Mar 27, 2008 1:51pm
Quoting drummer486
There are ways to hedge risk cross-market with a positive expectancy when certain inefficiencies exist. Below is an example:

Assuming the GBP/JPY is strongly correlated with the US equity markets, one could buy GBP/JPY and sell S&P futures with appropriate sizing such that a move up in the S&P would lose just as much as the GBP/JPY wins. The GBP/JPY position would be earning the interest-rate differential, however, giving a positive expectancy earning. Assuming one could have strong leverage in both contracts, the return on initial investment could be quite attractive with low risk. Of course, if the correlation btw GBP/JPY and the S&P falls apart, you are exposed to more risk than expected, but this change in correlation could occur in either direction, so the hedge is still positive expectancy.

I'm no expert, but I think this is correct. Can anybody find a hole in my argument?
yes this is a great example of how we can use hedging to our advantage. you are using multiple markets in your example, which is how most hedging is done. the intention of this thread was to uncover hedging opportunities WITHIN the currency markets...i gave one example (http://www.forexfactory.com/showpost.php?p=1861308&postcount=3)of how it can be done, but youll notice there have not been any other legitimate examples given (unless daytrader wishes to defend his example that we exposed LOL). thats because its hard to hedge without going cross market! most stuff that looks like hedging in a single market ends up being more like arbitrage or null positions.
Relax and be happy.
  • #25
  • Mar 28, 2008 12:52pm Mar 28, 2008 12:52pm
Quoting merlin
yes this is a great example of how we can use hedging to our advantage. you are using multiple markets in your example, which is how most hedging is done. the intention of this thread was to uncover hedging opportunities WITHIN the currency markets...i gave one example (http://www.forexfactory.com/showpost.php?p=1861308&postcount=3)of how it can be done, but youll notice there have not been any other legitimate examples given (unless daytrader wishes to defend his example that we exposed LOL). thats because its hard to hedge without going cross market! most stuff that looks like hedging in a single market ends up being more like arbitrage or null positions.
The only way to effectively hedge one currency pair with another is to ensure that they do not share any components. Thus, one could hypothetically hedge GBP/JPY with AUD/USD, knowing that they are both strongly driven by carry trades (especially with the decreasing US rates), but share no currency components. If these two pairs moved with high correlation, one could buy the higher-yielding pair and sell the lower-yielder, thus hedging your risk of carry-trade depreciation while still maintaining an interest rate differential. Of course, there are surely a number of other, much larger traders and institutions playing the same game, so this type of inefficiency might be hard to find. Regardless, the key is to understand WHY two pairs are correlated, and understand what would cause them to become less correlated in the future. In this case, the core cause is interest rates.
  • #26
  • Mar 28, 2008 1:08pm Mar 28, 2008 1:08pm
Buy oil future, hedge with USD/CAD long?
  • #27
  • Mar 28, 2008 1:32pm Mar 28, 2008 1:32pm
Quoting fierceman
Buy oil future, hedge with USD/CAD long?
a classic
Relax and be happy.
  • #28
  • Apr 23, 2010 6:55pm Apr 23, 2010 6:55pm
The only way i see a real 0 risk hedge is if someone buys you something today that wants to receive later, so you open at the moment the position, if the price lowers you earn the difference, if the price goes higher you dont loose the increase in price. If you plan to use this metod, Dont forget to deliver the merchandise at the delivery date!!!
  • #29
  • Last Post: May 4, 2016 5:40am May 4, 2016 5:40am
Here is how I approach mutual currency hedging. First I figure out weak and strong pairings of currencies. Then I try as far as possible to balance the volumes of weak and strong trade for each currency. This allows double sided trading of each currency, so that strong currencies are winging in a bullish market while weak ones are winning in a bearish market.

To illustrate this approach, here are the weak USD pairs: GBP/USD, EUR/USD, USD/JPY. They are weak because USD is paired with currently stronger currencies. The strong USD pairs are: USD/CAD, NZD/USD, AUD/USD. The latter pairs are strong because USD is paired with weaker currencies. USD pairs pairs generally trade long with USD as top pair, and trade short with USD as base pair.

So if I buy 20k GBP/USD, I can hedge it by buying 20k USD/CAD or selling 20k of NZDUSD. Once this is done, I have no need for the stop loss tool, which tends to closeout trades prematurely. Adjustments will continue to be made to individual trades to maintain positive P/L for the direction of trade without reversal. In other words a pair will continue to be bought at a lower price in the face of continuously falling price until it stabilizes with positive P/L. Hopefully this makes sense. I welcome questions and feedbacks here or at
http://www.dromekara.com/p/forex-updates_16.html?m=1.
Mecrandie
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