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whats with this "hedging" thing??

  • #121
  • Feb 14, 2008 3:20pm Feb 14, 2008 3:20pm
I'm not about to argue that the median line hedge strategy can't be done with conventional order types with similar outcomes. My point is that, IMHO, when market appears to be headed for a range I would rather use a strategy that makes profit REGARDLESS of price direction. Perhaps that's purely pschological, but I for one, hate stress.

While I'm at it, here's another subtle advantage I gained from hedging the median line. On one occasion while price was within the range, I noticed price was headed up towards strong resistance. I had no open positions, so I simply opened a long, then as price moved closer to resistance, I opened the short side. In effect, I had two potential winners for the spread cost of one. Did I pay for the spread of both positions? Technically perhaps, but as far as my equity at that time showed, the answer is NO! At that point I was sitting pretty knowing that all I needed was for a strong reversal near the range extreems to return price back home, safe and sound. If price broke out, I had the insurance that I wouldn't lose much because of my resting buy and sell stops that were convieniently located just beyond the 100 pip mark (just outside the range extreems)

That was some of the easiest money I ever made. Yes, I could have made money with simple stop and limit orders, but I would need to watch the charts more closely, knowing that one spike in the wrong direction could put a good sized loss on the books right away. Give me a flat range and a phoney hedge feature any day over a range and conventional order types.

Sometimes, easy does it.
  • #122
  • Feb 14, 2008 5:31pm Feb 14, 2008 5:31pm
It seems like we've come to some consensus here then. I'm going to try to summarize briefly:

First off, it seems fairly clear that, in terms of simple pip-by-pip accounting, hedging a trade is identical to reducing, eliminating, or reversing a position in the market with conventional orders.

Advantages

  1. Psychological - might reduce fear/greed
  2. Accounting - simplifies per-trade management
  3. Possible faster execution (for brokers who fill hedges differently than market/limit/stops)

Disadvantages

  1. Convolution of actual market position
  2. Always negative interest (for positions held inter-day or with Oanda-style calculation)

If the above advantages outweigh the possible interest cost for you, perhaps hedging could be useful. Otherwise, it's just another way for the brokers to increase their take.

  • #123
  • Feb 14, 2008 6:21pm Feb 14, 2008 6:21pm
Quoting drummer486
It seems like we've come to some consensus here then. I'm going to try to summarize briefly:

First off, it seems fairly clear that, in terms of simple pip-by-pip accounting, hedging a trade is identical to reducing, eliminating, or reversing a position in the market with conventional orders.

Advantages

  1. Psychological - might reduce fear/greed
  2. Accounting - simplifies per-trade management
  3. Possible faster execution (for brokers who fill hedges differently than market/limit/stops)

Disadvantages

  1. Convolution of actual market position
  2. Always negative interest (for positions held inter-day or with Oanda-style calculation)

If the above advantages outweigh the possible interest cost for you, perhaps hedging could be useful. Otherwise, it's just another way for the brokers to increase their take.


Excellent summary!

I move we adjourn.
  • #124
  • Feb 14, 2008 6:26pm Feb 14, 2008 6:26pm
Quoting capitalist88
Excellent summary!

I move we adjourn.
I sssecond that before sssomeone decccides to sssummarize the sssummary of the sssynopsis. All in favor, sssay I.
  • #125
  • Feb 15, 2008 8:10am Feb 15, 2008 8:10am
I or Aye?
The basis of a democratic state is liberty. ~ Aristotle
  • #126
  • Feb 15, 2008 9:34am Feb 15, 2008 9:34am
Quoting drummer486
First off, it seems fairly clear that, in terms of simple pip-by-pip accounting, hedging a trade is identical to reducing, eliminating, or reversing a position in the market with conventional orders.

Advantages

  1. Psychological - might reduce fear/greed
  2. Accounting - simplifies per-trade management
  3. Possible faster execution (for brokers who fill hedges differently than market/limit/stops)

Disadvantages

  1. Convolution of actual market position
  2. Always negative interest (for positions held inter-day or with Oanda-style calculation)

excellent summary, we were in need of one

before i give my blessing i think we should add two disadvantages:

- margin can be taken on one or both positions, depending on the broker.
- a second spread must be paid to remove the hedged position because you will incur negative rollover if you leave it open (unless you close half of the hedge to establish a new position you would have taken anyway).

and as for the advantages, i think it is a stretch to say "Possible faster execution". if we could get just one single broker to admit that they treat a hedge order differently i would change my mind here. but like i said earlier, i would be totally floored if a broker admitted this. admission would mean the broker admits to being a dirty market maker. a buy order should be treated the same whether it is an entry, exit or "hedge".
Relax and be happy.
  • #127
  • Feb 15, 2008 12:45pm Feb 15, 2008 12:45pm
Quoting merlin
i think it is a stretch to say "Possible faster execution". if we could get just one single broker to admit that they treat a hedge order differently i would change my mind here. but like i said earlier, i would be totally floored if a broker admitted this. admission would mean the broker admits to being a dirty market maker. a buy order should be treated the same whether it is an entry, exit or "hedge".
Like I said, this is an outdated advantage as I don't know of any brokers that still do this. FXCM was the big one that used to, but it was well documented. I used to trade in a company with 13 others around me, and we would all use "stops" as orders to get us into larger spikes with FXCM because it was almost a guarantee'd slip whenever you used an entry order.
The basis of a democratic state is liberty. ~ Aristotle
  • #128
  • Edited 2:40pm Feb 15, 2008 12:55pm | Edited 2:40pm
Hi ALL,

Sorry that I have not been active in the Trading Room. I had been very engaged at my thread at the common area, as well as some other personal chores.

Initially , I had this same issue bugging me, about the retail Fx broking accounting standards.

Having being a spot fx man and a futures exchange member in my career, I find it disturbing that this erroneous accounting practise is being adopted by the retail fx brokers.I thought that this was the practise only by bucket shops.This surely is not the practise of good houses and banks of which are known to me. As far as I know, FIFO (First in First out) is the accounting standards of the industry.

Now that we can see of its abuses, after the discussion in this thread.

I hope that I do not overstep myself to request, if forexfactory, can start a sticky to identify all the brokers who are practising this mode of book accounting. And brand them as practising bad accounting and thereby clean up the act of all this malpractise from this industry which is in its's infancy. In doing so, send a message to brokers to be aware that not all retail forex traders can be suckered into brokerage wasting, self deceiving trades. And hiding actual losses by masking them as unrealised losses.

Myself, not being well informed on the brokers who are operational, as well as their Modus Operandi, I hope that this can be a community project, lead by the Forum owners as a good advicement to all here.

Thank You Merlin for this thread.

regards.
  • #129
  • Feb 15, 2008 1:49pm Feb 15, 2008 1:49pm
Update for Merlin (and for accuracy). Changes are italicized.

Hedging a trade is equivalent to taking a second trade opposite the trade, closing that second trade, and then closing the original trade. That means twice the spread cost for exactly the same position change as just closing part or all of the original trade.

Advantages

  1. Psychological - might reduce fear/greed
  2. Accounting - simplifies per-trade management (could also use separate or sub-accounts)
  3. Possible faster execution (for brokers who fill hedges differently than market/limit/stops) (dubious)


Disadvantages

  1. Double spread cost!
  2. Convolution of actual market position
  3. Margin can be taken on one or both positions (depending on broker)
  4. Always negative interest (for positions held inter-day or with Oanda-style calculation)


If the above advantages outweigh the possible interest/spread cost for you, perhaps hedging could be useful. Otherwise, it's just another way for the brokers to increase their take.

----

fti - I think that's a great idea. Since so many retail brokers are not regulated by the NFA/CTFC, it's up to us to set them straight . If not ending the practice altogether, it would at least be prefrable to make the brokers actually inform their customers of the extra costs. Also, many thanks to Merlin for bringing up the issue and correcting my errors .

Ok - I'll now butt out and quite summarizing things. Happy trading!

  • #130
  • Feb 19, 2008 11:41am Feb 19, 2008 11:41am
Quoting fti
As far as I know, FIFO (First in First out) is the accounting standards of the industry.
this is the best post in this thread fti! your institutional experience shines through with such high level observations. i explained many times in this thread that hedge orders should not be treated differently from any other order, and you nailed the reason why: FIFO! if a broker is not treating orders in a FIFO manner they would be considered a trickster. this is why i said that no broker would ever admit to treating hedge orders differently...they know FIFO is the honest way to do business.

i appriciate your idea about a sticky thread, but im not sure i want to spend the next 6 months championing this cause LOL. i would support anyone who decided to do so though

glad to see you back in the TR, i really hope you will drop some more knowlege in the near future
Relax and be happy.
  • #131
  • Feb 19, 2008 11:45am Feb 19, 2008 11:45am
Quoting drummer486
Hedging a trade is equivalent to taking a second trade opposite the trade, closing that second trade, and then closing the original trade. That means twice the spread cost for exactly the same position change as just closing part or all of the original trade.

Advantages

  1. Psychological - might reduce fear/greed
  2. Accounting - simplifies per-trade management (could also use separate or sub-accounts)
  3. Possible faster execution (for brokers who fill hedges differently than market/limit/stops) (dubious)

Disadvantages

  1. Double spread cost!
  2. Convolution of actual market position
  3. Margin can be taken on one or both positions (depending on broker)
  4. Always negative interest (for positions held inter-day or with Oanda-style calculation)

amen and hallelujah!
Relax and be happy.
  • #132
  • Feb 19, 2008 11:51am Feb 19, 2008 11:51am
Okay, I need to understand one thing here.

How is the position in 1 currency pair hedged with a position in another currency pair, how is the calculation done and how effective is it.

How is the hedging done for wednesday rollover.
  • #133
  • Feb 19, 2008 1:02pm Feb 19, 2008 1:02pm
Quoting forexlion
Okay, I need to understand one thing here.

How is the position in 1 currency pair hedged with a position in another currency pair, how is the calculation done and how effective is it.

How is the hedging done for wednesday rollover.
it sounds like you are talking about the real kind of hedging. im not sure its a good idea to mix up discussions on real hedging and the "hedge feature" on the broker platforms...if you open a new thread on the subject i would be happy to join in, real hedging is a useful and very complex subject worthy of discussion
Relax and be happy.
  • #134
  • Mar 17, 2008 6:47pm Mar 17, 2008 6:47pm
So I killed this thread with my summary before, but I was thinking about this again recently, and I now have a conjecture (with example) and then a question.

First a quick assumption: equity = balance + unrealized P/L

Then...

Conjecture:

Hedging allows one to increase the account balance with no change (or a small decrease due to price/interest spread) in account equity.


Example:

Say I have a $50,000 account allowing up to 100:1 leverage with a broker that requires only one side worth of margin for a hedged position (CMS forex, for example). I go long 5 standard lots GBP/USD and immediately hedge with a 2 pip spread. My account equity is immediately down those two pips of spread, and my balance is unchanged. GBP/USD price moves up 50 pips. I close my long order, increasing my balance by the amount of profit made on that long. My short GBP/USD hedge is now exposed, and I see an unrealized loss approximately equivalent to the profit I just gained on the long. Thus, my account equity remains approximately the same, as does my available margin. I then immediately hedge this short trade again, costing me another 2 pips * 5 lots. Now the account balance has increased by a gross 50 pips * 5 lots and I have an unrealized loss of 54 pips * 5 lots, giving a net equity loss of 4 pips * 5 lots. At each rollover, I will have to pay the interest spread the broker maintains on the pair, probably something like 2% APY on the notional size of the orders depending on the broker.


Discussion

As you can see, this results in a 50 pips balance gain, but only a 4 pip (immediate) loss in account equity. So the question is, what parameters do brokers calculate based upon your account balance (not equity)?

One example might be if your broker gave better spreads to individuals with higher account balances. Your account balance could be doubled a few times with only a 5 or 10% drawdown in actual equity.

Keep in mind that under such high leverage (5 std lots GBP/USD on $50K account is approx 20:1), this accounting anomaly should NOT be used long-term. If the broker's interest spread were in fact 2%, the account equity would drop by approx $55 per day. At the end of the year, that results in a $20K drawdown!

So essentially what I'm saying here is that all the same principles that we deduced before hold. For purposes of account equity, hedging is identical or worse than being out of the market. There just might be an opportunity to exploit brokerage accounting inefficiencies if they base certain rewards on account balance rather than equity.


Ideas?

Ok, that was a lot of information. Does anybody have examples of things that might be balance- (but NOT equity-) dependent?
  • #135
  • Edited 1:15am Mar 18, 2008 1:14am | Edited 1:15am
drummer, besides the account balance vs. equity advantage there is also another advantage and that is the number of "round-trades". Still, I doubt that any account balance benefits you get would match what you lose paying the double spread.

Have a look at this for example: http://www.clickforex.com (click on "Promotions")

These guys offer "Rewards" points based on your volume, so if you "hedge" your number of round trades goes up and you earn more rewards points. I still think this is silly since the rewards certainly don't add up to more than what you lose on the spread - if they did Click Forex wouldn't be a business but a charity. In fact, the whole rewards program seems like a thinly disguised, casino-style way of simply saying "we have lower spreads" than it may seem at first. Still, it's creative marketing so I thought I'd mention it.

So let me re-iterate once again:

"HEDGING" provides no logical advantage to the trader. In fact, it slowly bleeds your account equity, which is the true measure of "how much withdrawable money you have in your account". Instead of hedging, why don't people just make DONATIONS to their broker???

EDIT: Just for the record, I am not promoting Click Forex... Feel free to remove the link if it violates the TOS.
  • #136
  • Edited 2:28pm Mar 18, 2008 2:16pm | Edited 2:28pm
Quoting drummer486
As you can see, this results in a 50 pips balance gain, but only a 4 pip (immediate) loss in account equity.


i see 4 pips of spread (with another 2 pips needed to exit the trade completely) with no change in equity. where are you getting these 50 pips from??

- you went long
- you went short (hedging the long)
- you went short (to close the long)
- you went long (hedging the short)

this looks like a zero position to me, what am i missing?
Relax and be happy.
  • #137
  • Mar 18, 2008 6:50pm Mar 18, 2008 6:50pm
Quoting merlin

i see 4 pips of spread (with another 2 pips needed to exit the trade completely) with no change in equity. [...] this looks like a zero position to me, what am i missing?
That's exactly what I'm saying ...

(emphasis added)
Quote
First a quick assumption: equity = balance + unrealized P/L
So by hedging, then closing the profitable side of the hedge, we increase the account balance by an amount nearly identical to the unrealized P/L.

Quote
So essentially what I'm saying here is that all the same principles that we deduced before hold. For purposes of account equity, hedging is identical or worse than being out of the market. There just might be an opportunity to exploit brokerage accounting inefficiencies if they base certain rewards on account balance rather than equity.
Quote
Does anybody have examples of things that might be balance- (but NOT equity-) dependent?
The point here being that I've only worked with a couple retail brokers, but I've seen enough to know that there are a lot of shady practices out there trying to get newbies to invest large amounts. Assumedly, some of these might appear as a function of account balance. Hedging in the manner I wrote of would allow us to increase the account balance without assuming any risk. We will of course see an unavoidable equity drawdown from the price and interest spreads, but if the broker's balance-based incentive outweighed these costs, we might be able to exploit this inefficiency for an effectively zero-risk gain.
  • #138
  • Mar 19, 2008 1:00am Mar 19, 2008 1:00am
drummer, I understand what you're saying, but I strongly doubt you will find a broker who will give you any kind of benefits on account balance that would exceed your losses in equity as a result of "hedging".

Like I was saying in my previous post, rewards are sometimes given for volume, but not really for account balance anyway (not that I've seen anyway).
  • #139
  • Mar 19, 2008 1:14pm Mar 19, 2008 1:14pm
Quoting drummer486
That's exactly what I'm saying ...

(emphasis added)
oh

well in that case, you are a genius! (i always say that to people when they agree with me )
Relax and be happy.
  • #140
  • Mar 20, 2008 2:01pm Mar 20, 2008 2:01pm
Quoting boxingislife
i know im gonna be criticized to death because of this
good guess! LOL

we already ironed out why hedging is flawed, AT THE ROOT. no matter how you use it, your strategy could be improved by not using it. take the time to read this thread, we illustrated perfectly the logic of why there is no possible advantage to the hedge feature. if you think it is useful, you are being fooled by the complexities of your strategy and should break down the components to get a better understanding of your own strategy. you post here does nothing to further our discussion, youve presented no logic to debate...just another murky, misguided "feeling" as to why hedging is useful. if you cant figure it out go ahead and post your strategy here and i will show you exactly why the strategy can be improved by NOT using the hedge feature (but still achieving the same results).
Relax and be happy.
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