What is hedging? | Forex Factory

Options

Permalinks
Print Thread

Similar Threads

The Barak Hedging Method 1 25 replies

Hedging 34 replies

Hedging anyone? 0 replies

Hedging 7 replies

Hedging strategies 7 replies

What is hedging?

  • #1
  • First Post: Feb 27, 2007 12:33am Feb 27, 2007 12:33am
Just curious about what hedging means in regards to forex.
  • #2
  • Feb 27, 2007 4:26am Feb 27, 2007 4:26am
Hedging simply means offsetting your risk by placing additional bets.

This can be done in more than one way:
- A correlated hedge bet is one that uses a highly corrrelated (or highly negatively correlated) rate and placing bets in opposite directions. For example, the GBP/USD and USD/CHF are highly negatively correlated meaning they generally move in opposite directions most of the time. If you were to buy 1 lot of the GBP/USD and buy 1.9 (fluctuates based on the GBP) of the USD/CHF, your account fluctuations should be very subdued most of the time.

- A currency hedge bet is one where you buy and sell a currency in 1 or more accounts so that your asset fluctuation is virtually zero. You would do this (normally) to protect profits when you want to keep a particular position open.

Reasons for hedging may vary.

I hope this helps.

Regards,
Michael

Quoting vder
Just curious about what hedging means in regards to forex.
  • #3
  • Feb 27, 2007 5:13am Feb 27, 2007 5:13am
There are some very specialized forums about Hedge strategies out there. A google will do. The moderator here forbids me to give you some links.

In general I can elaborate a bit on what mrmikal said:

The correlated hedge is in my eyes an illusion. Why ? Because it substitutes the normal trade TA for the search for the correlation. What is exactly the same. So it gives no security. Lets take as an example a popular hedge pair the GBP/JPY CHF/JPY. It is mainly hedged in order to eliminate risk and to profit from the swap. The correlation between these 2 pairs is not aproximatively 1.9 or 2, like some people use, it is EXACTLY equal to the missing link in the triangle and that is GBP/CHF. If you buy, at this moment that I write this, 1 lot GBP/JPY and sell 2.4059 lots of CHF/JPY than you have a perfectly correlated hedge (minus the spread). Unfortunately the GBP/CHF is not a rock, it moves also. Now you are back at square 1, you have to analyze GBP/CHF, or this hedge will make you poor in no time. I have made a comprehensive study on this type of hedge. Forget it !

An other solution is what they call a 100% hedge or a futile hedge. You simply sell and buy the same pair at the same time. The sum will be zero except for the swap. People do this with 2 brokers. One who pays interest and an other who does not charges interest. What they are actually doing is abusing the forex brokers to borrow money from them, roughly equal to the leverage, that is usually 100x there deposit. The inconvenience is that you have always to “carry” money from the winning account to the losing one. But even for that is now a solution. There are now online “banks” who offer a service for instant payment from one broker to the other. I haven’t done this yet because it’s not based on a sound system. I simply don’t thrust it. And I believe that, all that is some form of abuse can never … go on for ever.

Hope this helps

CatMan
  • #4
  • Feb 27, 2007 10:08am Feb 27, 2007 10:08am
Cat,

Thanks for the elaboration.

A few quips, though:
- hedging through correlation is valid, and yes, you're right, you may have to monitor the cross currency. However, it's not necessarily a bad thing...some cross currency rates are more predictable than others, and are much less volatile. Using that information to your advantage, you can help to arrange and manage the hedge so that it produces positive growth through both the swaps and the movement in the cross currency. For example, if you see a well defined uptrend in the cross currency, it would be better to overweight the base currency. In your example of the GBP/JPY CHF/JPY, that will increase the amount of swap you take while the hedge grows a little faster. A turn in the cross-currency will normally precede the fall in the hedge equity in which case you can underweight the base from equilibrium and subdue the movement. It's not exactly an exact science, but hedge trading like all forms of trading requires some work. I think where you are correct is that the idea of the hedge has been to be more of a simply "set it and forget it" growth (or at least not have to actually TRADE). That mindset leads to an oversimplification of what true hedging is about...which, in my opinion is about placing multiple bets to reduce drawdown and maximize growth. Correlations are all relative and can (in most cases) vary daily...however, understanding of the movements of those correlations can lead to a form of fund management that allows you to make safer bets.

- a futile hedge as you call it is not necessarily abuse. It's only abuse if you use fraud to obtain your accounts. If your broker allows you the priviledge of a certain type of account, then using that account cannot be abuse. As far as moving money back and forth, you are correct, it can be a pain...but it is merely a pain and not necessarily any worse than having to trade on analysis. Technically, when I do this, I need to use analysis to predict which account to prepare to overweight. Again, this type of hedging isn't a set and forget type hedge...but I can say it produces a pretty nifty profit.

- For most newbies, I don't recommend hedging as well. It only increases the number of currency pairs you have to monitor.

Quoting CatMan
There are some very specialized forums about Hedge strategies out there. A google will do. The moderator here forbids me to give you some links.

In general I can elaborate a bit on what mrmikal said:

The correlated hedge is in my eyes an illusion. Why ? Because it substitutes the normal trade TA for the search for the correlation. What is exactly the same. So it gives no security. Lets take as an example a popular hedge pair the GBP/JPY CHF/JPY. It is mainly hedged in order to eliminate risk and to profit from the swap. The correlation between these 2 pairs is not aproximatively 1.9 or 2, like some people use, it is EXACTLY equal to the missing link in the triangle and that is GBP/CHF. If you buy, at this moment that I write this, 1 lot GBP/JPY and sell 2.4059 lots of CHF/JPY than you have a perfectly correlated hedge (minus the spread). Unfortunately the GBP/CHF is not a rock, it moves also. Now you are back at square 1, you have to analyze GBP/CHF, or this hedge will make you poor in no time. I have made a comprehensive study on this type of hedge. Forget it !

An other solution is what they call a 100% hedge or a futile hedge. You simply sell and buy the same pair at the same time. The sum will be zero except for the swap. People do this with 2 brokers. One who pays interest and an other who does not charges interest. What they are actually doing is abusing the forex brokers to borrow money from them, roughly equal to the leverage, that is usually 100x there deposit. The inconvenience is that you have always to “carry” money from the winning account to the losing one. But even for that is now a solution. There are now online “banks” who offer a service for instant payment from one broker to the other. I haven’t done this yet because it’s not based on a sound system. I simply don’t thrust it. And I believe that, all that is some form of abuse can never … go on for ever.

Hope this helps

CatMan
  • #5
  • Feb 28, 2007 11:09am Feb 28, 2007 11:09am
wow...i am still clueless. I will definitely do more research on this item. Sounds very intriguing though. thanks guys for the responses.
  • #6
  • Mar 2, 2007 11:22pm Mar 2, 2007 11:22pm
i don't understand as well.maybe someone can put a hedging example on cable?
  • #7
  • Mar 2, 2007 11:48pm Mar 2, 2007 11:48pm
well, the only hedge on cable you can do is this:

you have a bid at 1.9435 and ask at 1.9440...let's say you're unsure of which direction the market is going to go in the next few minutes, but you want in. So you BUY at 1.9440 and you SHORT at 1.9435...this would be a hedged trade...not particularly useful, so here's a better example:

Let's say you have a long trade that's up 50 pips...the weekend is coming and you'll be out of town but you'd rather not give up the position. So you can take a SHORT position equal to your long position and preserve the 50 pips.

Let's say when you come back the market has resumed the uptrend and you believe your long position is still valid...so you drop the short position and keep the long position. This may be useful because normally when you take out a hedge, you don't have to provide the extra margin...meaning you don't really risk anything but the spread to preserve a position.

Again, not exactly useful, but you could probably creatively use hedges to trap a ranging market. For example...let's say you're unsure of which direction the market is going, but you know it'll be in a range for a while...so you take a hedge trade out and put TP on both trades and let the market move in both directions and collect pips on both ends.

Hope that helps

Quoting amenlo9
i don't understand as well.maybe someone can put a hedging example on cable?
  • #8
  • Mar 5, 2007 2:17am Mar 5, 2007 2:17am
Hi guys!

There are 3 main reasons why to hedge, that I know:

1) Because you want to eliminate the trade risk. You want only to collect the overnight interest, called the “swap”. There are 2 ways to do this, like I described above, 100% hedge with the same currency pair and 2 brokers, and correlated hedge with 2 correlated currency pairs on the same account.

2) You want to soften the trade risk. In this case you want an other instrument as a safety net for when the currency you are trading leaves the range in which it is supposed to stay. But you don’t want this instrument to move with the small ups and downs that you are trading. This should be possible with an option. If you want to know more about this, google than “Forex Options” and you will find plenty websites competing to explain you more.

3) You want to speculate on the correlation swing. This goes really far! In order to do this we have to eliminate the problem of imprecise correlation. Because 2 pairs are in a correlation that is NOT STEADY, it is not enough to open the position in one pair in a quantity of lots, that exactly compensates for the first pair. So we will close the ring by opening positions in 3 currency pairs at the same time. We need an other pair that compensates for this “swinging relation” between the two first pairs.
Example: Buy EUR/USD, Buy USD/CHF, Sell EUR/CHF
Lets, for the simplicity, inverse the USD/CHF pair, this gives us :
Example: Buy EUR/USD, Sell CHF/USD, Sell EUR/CHF
Now you can easily understand that the value of the EUR expressed in USD is, in this period in history, bigger than the value of the CHF expressed in USD, so we will need an other pair to short, if we want to make a perfect hedge. We close that circle with additionally shorting the EUR/CHF. Because this pair is the “correlation pair” of the EUR/USD and USD/CHF. It contains EUR and CHF without the USD. In this way we form a triangle that gives at any given moment a sum equal to zero. Is that so? Uh … no! It happens to be so that, sometimes, this zero sum gets for a very short period of time, you think here on minutes, out of balance for some 10 to 20 pips, after which it quickly restores to zero. There are people out there who try to speculate on this phenomenon. A guy called Michal Kreslik has made an elaborate study on this trading technique. However … brokers hate you if you trade that fast. Specially if this correlation imperfections happens during news events when the market goes bananas. They know how to stop you, trust me.

Hope this helps too,
Catman
  • #9
  • Mar 5, 2007 2:25am Mar 5, 2007 2:25am
Quoting vder
Just curious about what hedging means in regards to forex.
It's when you pay extra spreads and commissions for the privledge to use bad discipline. :
  • #10
  • Mar 5, 2007 7:43pm Mar 5, 2007 7:43pm
is it hedging call straddle as well?
  • #11
  • Mar 5, 2007 11:32pm Mar 5, 2007 11:32pm
Not necessarily.

A straddle is opening 2 pending orders in different direction so that as the price moves in one direction, it may or may not pick up one side of the straddle with the hope of a trend continuation.

Hedging is simply the buying and selling of a single rate or buying and selling of highly correlated rates to reduce risk.

Quoting amenlo9
is it hedging call straddle as well?
  • #12
  • Mar 7, 2007 9:21pm Mar 7, 2007 9:21pm
Hi,

Has anybody any familiarity with Hedging a high yielding pair such as the GBP/JPY or USD/JPY using any form of options?

I was looking specifically at options issued by the PHLX? (As this idea has been run by me before but I never actually paid attention to the mechanics of it!!!)...

Anybody have any idea it would be nice to hear about it..

Thanks
  • #13
  • Apr 4, 2007 1:15pm Apr 4, 2007 1:15pm
One other way to hedge a FX carry trade is to hedge it with currency futures.
You can balance the difference in unit price by having fractions of a FX position. ie: 120k E/U fx vs 100k EURO future.
This almost solves the unit price problem but the damn things don't always move in unison and you can take a beating.
Also, you have to roll the future position every 3 months or so as well as fund the losing account.
  • #14
  • Sep 2, 2007 4:43am Sep 2, 2007 4:43am
A few new things I recently found out about hedging.



1) there are now brokers who offers a demo account for FX options, like finotec. So I could now finally find out what such an option contract cost. I read often about the possibility to hedge a trade with an option. In reality this is not an "option" . Because the premium (or the cost you have to pay to open the option contract) is very very expensive.
Lets say you want to hedge a trade for the possibility that it goes 100 pips against you, in which case you want to execute your write to buy the pair at the 100 pips lower price so that you compensate your loss. The premium will cost you more than 50 pips and even more than 75 pips depending on the time between the time you open the option contract and the expiration date. Than you still have the possibility that, at expiration date, the price is not above the 100 pips level in which case you lose on your trade but your option gives you possibly not even the premium back. So you are fxxed from every corner.

2) This BPS or "broker processing service" that was supposed to make transfer from one broker account to the other in real time, like you pay your Skype bill with a money bookers account. Forget that one too. I read that their service really sucks and that it can even take up to a week before the money arrives. Imagine that you are in a 100% hedge with 2 accounts on 2 different brokers trading the same pair long on one and short on the other broker. I you need to carry the money from the winning to the losing account. You will have to close your hedge and wait till the money gets in the other account.

3) A simple thing I never realised is this: Lets say you have for your 100% hedge on 2 brokers 1 lot short at "no_swap_BROKER_X" and 1 lot long at FXDD both GBPJPY . So you will earn 26 $ per day swap. Fantastic? Nope! Because nowadays the GBJPY goes easily 1000 pips one way in 1 day. But this means 10.000$ plus and 10.000$ loss on the respective accounts and now comes the problem: you can not simply transfer the profit, you have first to close the trade on the winning account and than transfer. And open a new trade with again 8 pips spread. But you earn only 2.6 pips a day. Now if you calculate how much money is in circulation to earn less than 26$ a day ... I think I will stick with normal trading.
This type of hedging should be fine if there was a way to transfer the money between the 2 accounts instantaniously. If anybody knows a way, please enlighten us.
  • #15
  • Sep 3, 2007 10:46am Sep 3, 2007 10:46am
I use Hedge in Forex trading. This is a very important tool for me. Why? Because in the currency markets you never know what happens next! Nobody can predict the price movement in the future.

With Hedge I can reduce or protect my losses. There are many ways how to use hedge. The only hedge that I use is the Strangle in the same currency pair. Works very well!!
  • #16
  • Last Post: Jan 20, 2008 9:21am Jan 20, 2008 9:21am
Quoting vinnie99
I use Hedge in Forex trading. This is a very important tool for me. Why? Because in the currency markets you never know what happens next! Nobody can predict the price movement in the future.

With Hedge I can reduce or protect my losses. There are many ways how to use hedge. The only hedge that I use is the Strangle in the same currency pair. Works very well!!
Hello vinnie,

Please, I want you to share with us a very simple and profitable way of hedging you have been using so far. this is because I also find it useful particularly in reducing trader's emotions.
What do you see abou this strategy?

Buy and sell at the same time
Close profit during retracement and allow the loss to retrace.

Can you share your views on this, or give a better and more paractical one.
0 traders viewing now