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Hedge and Correlation Strategy

I would like to offer my humble idea on trading correlations.

It’s been said by many that drift will kill an account. No doubt you can enter on a certain gap size and watch it grow and grow. That is the danger.

Why not only take the trades in the direction of the longer term drift? Put drift to work!

With that said, I pegged Eur/Usd vs. Gbp/Usd to Jan. 1 2001 through to the present. I then did the same thing for 2002 and so on. All the charts showed the same drift, and that is the Eur/Usd rising and the Gbp/Usd sinking.

For that particular correlation it may be better odds to wait for the gap on the shorter time frame that lets you take long Eur/Usd vs. short Gbp/Usd. There may be fewer signals but better odds?

If anyone feels I’m on the wrong track, let me have it.

BTW Dreamliner, another quality thread. My thanks to you!
Quoting siafx
I would like to offer my humble idea on trading correlations.

It’s been said by many that drift will kill an account. No doubt you can enter on a certain gap size and watch it grow and grow. That is the danger.

Why not only take the trades in the direction of the longer term drift? Put drift to work!

With that said, I pegged Eur/Usd vs. Gbp/Usd to Jan. 1 2001 through to the present. I then did the same thing for 2002 and so on. All the charts showed the same drift, and that is the Eur/Usd rising and the Gbp/Usd sinking.

For that particular...
The problem with this methodology is that you dont know when to enter. The gap can be 100, 500, 1000 or many 1000s on the higer timeframes. Overlaying and trading correlation's is a misconception by new traders who really should know better. In September 2008 I blew a 6K Demo account on EURUSD/USDCHF using 0.50 lotsize thinking the gap size of 1700 on 15M timeframe was sufficient, it wasnt. The gap size increased to 2600 (before retracting) for no apparent reason other than banks were consolidating their USD positions in the market.

You may be able to make lots of small profitable trades using this method but when the killer gap comes then your profits will be wiped out big time.

Just remember the old scenario, if it was this simple then................
I think this post is correct.

Quoting scooby-doo
The problem with this methodology is that you dont know when to enter. The gap can be 100, 500, 1000 or many 1000s on the higer timeframes. Overlaying and trading correlation's is a misconception by new traders who really should know better. In September 2008 I blew a 6K Demo account on EURUSD/USDCHF using 0.50 lotsize thinking the gap size of 1700 on 15M timeframe was sufficient, it wasnt. The gap size increased to 2600 (before retracting) for no apparent reason other than banks were consolidating their USD positions in the market.

You may be...
Quoting scooby-doo
The problem with this methodology is that you dont know when to enter. The gap can be 100, 500, 1000 or many 1000s on the higer timeframes. Overlaying and trading correlation's is a misconception by new traders who really should know better. In September 2008 I blew a 6K Demo account on EURUSD/USDCHF using 0.50 lotsize thinking the gap size of 1700 on 15M timeframe was sufficient, it wasnt. The gap size increased to 2600 (before retracting) for no apparent reason other than banks were consolidating their USD positions in the market.

You may be...
... because trading EURUSD vs. USDCHF is nothing else than trading EURCHF. The same for e.g. EURUSD/GBPUSD, you are trading EURGBP. This has been said many times in all forex forums. You are wasting your time trying to trade these correlations...

You may get a feeling it works for some time and that is just because EURCHF is quite "lazy" and is ranging most of the time - this is the time correlation strategy may work. Once it gets trending strongly you will lose all.
This is not true, mathematically speaking. Granted you are trading "in the direction of" EUR/GPB, but it is not the same as trading EUR/GBP.

Quoting hotstorm
... because trading EURUSD vs. USDCHF is nothing else than trading EURCHF. The same for e.g. EURUSD/GBPUSD, you are trading EURGBP. This has been said many times in all forex forums. You are wasting your time trying to trade these correlations...

You may get a feeling it works for some time and that is just because EURCHF is quite "lazy" and is ranging most of the time - this is the time correlation strategy may work. Once it gets trending strongly you will lose all.
Quoting Dreamliner
This is not true, mathematically speaking. Granted you are trading "in the direction of" EUR/GPB, but it is not the same as trading EUR/GBP.
Ok, go and lose your money. I guarantee.

Try opening:
Long 1 lot EURUSD
Long [current rate of EURUSD, currently 1.3918] lot USDCHF
Short 1 lot EURCHF

If there is no spread and swap you get perfect hedge.... You won't lose but you also never make any profit. In reality you will be slowly losing on swaps, plus spreads.
Quoting Dreamliner
This is not true, mathematically speaking. Granted you are trading "in the direction of" EUR/GPB, but it is not the same as trading EUR/GBP.
Plus, how can you explain why this is true anytime you take current bids:

EURUSD Bid 1.39125 = A
GBPUSD Bid 1.61877 = B
EURGPB Bid 0.85927 (A/B = 0.8594488)

USDCHF Bid 1.08843 = C
EURCHF Bid 1.51454 (A*C = 1.514278)
Attached Image
Yes the difference between the two pairs is generally going to be constantly getting bigger or smaller on the long term, so if you hold a trade for weeks, you will either seriously make money, or seriously lose it. That's why I think the key part of this is to reset the zero point every day.

If the GBPUSD daily range is 300 pips, and EURUSD is 150 pips, and you've got some good room to profit from the *difference*.

Take a look at the attachment. For June 2009, if you had bought one lot GBPUSD and sold one lot EURUSD at 00:00 everyday, and closed the trade at the same time the next day, then repeating, you made 613 pips. (no I didn't include the broker's spread in the calculation...but go ahead and add it in if you want I (-6 pips from each trade)).

Looks like you would have blindly made money. I've gone back to the start of 2008 and done this. You can too. It's pretty interesting.

The key element is, of the 2 pairs you need to pick which one is moving faster (generally GBPUSD, but not always), and then you want to enter the trade in the direction of that pair.

What's outlined above isn't good enough...it needs refinement. And if anyone thinks I've done something wrong with my calculations, please let me know..
Attached File(s)
File Type: pdf Correlation_Strategy_June2009.pdf   40 KB | 2,384 downloads
I suppose for the sake of argument one could do the same calculation just buying GBPUSD at the same times to see what the difference is. Also as you suggest, GBPEUR...
Quoting Dreamliner
I think this post is correct.
By the way, I wasnt trying to knock down this methodology or thread. But, if you wish to hedge then try the following when a new bar begins on the daily timeframe...

For negative correlated pairs. <= -0.8

IF, EURCHF is trending upwards

BUY 1 Lots of EURUSD
BUY 1 * EURUSD/USDCHF Lots of USDCHF

IF, EURCHF is trending downwards

SELL 1 Lots of EURUSD
SELL 1 * EURUSD/USDCHF Lots of USDCHF

Close out for profit or loss just before the end of the day. Now, how do we know EURCHF is trending in either direction...

IF EMA25 EURCHF > EMA50 EURCHF = TREND UP

IF EMA25 EURCHF < EMA50 EURCHF = TREND DOWN

For this investigation, you should use DAILY chart for all three pairs.

...and finally, dont enter the trades if that day there is economic/news statements affecting USD.

In theory, if you follow the above to the letter then you should have more profitable days than not. Also because we are BUY/BUY and SELL/SELL drawdowns and potential losses will be allot lower than if we were BUY/SELL or SELL/BUY.

It is not perfect but a better type of methodology to follow. REMEMBER, dont trade if there are USD announcments coming up for the new day.

Try it on demo for a week and see how you get on.

Best of luck.
Quoting scooby-doo
By the way, I wasnt trying to knock down this methodology or thread. But, if you wish to hedge then try the following when a new bar begins on the daily timeframe...

For negative correlated pairs. <= -0.8

IF, EURCHF is trending upwards

BUY 1 Lots of EURUSD
BUY 1 * EURUSD/USDCHF Lots of USDCHF

IF, EURCHF is trending downwards

SELL 1 Lots of EURUSD
SELL 1 * EURUSD/USDCHF Lots of USDCHF

Close out for profit or loss just before the end of the day. Now, how do we know EURCHF is trending in either direction...

IF EMA25 EURCHF > EMA50 EURCHF...
This is something very similar to Spieler hedge trading method.The link is here.
http://www.forexfactory.com/showthread.php?t=95721

I trade this method on live for a while already. Still profitable.
Quoting the2001km
This is something very similar to Spieler hedge trading method.The link is here.
http://www.forexfactory.com/showthread.php?t=95721

I trade this method on live for a while already. Still profitable.
Yes, it does work unless your enter trades on days when there is economic/news statements regarding USD. You may ofcourse be on the correct side (luck 50/50) but if not then you will suffer mega drawdowns and possibly loses.

I did allot of studying on this and it seems that economic/news statements for EUR dont really impact your profit/loss as much as the USD ones do. It fails if people ignore this rule.

I know full well that this can seem frustrating, as when you are new to Forex, you want to be trading every BAR and in the market 24/5. But, you can ofcourse trade other strategies on other pairs to build up your portfollio of exposure.

If you want to Hedge, for whatever reason, then follow exactly what i have said above and you will learn allot a long the way and make some nice profits.

Good luck all.
Quoting the2001km
This is something very similar to Spieler hedge trading method.The link is here.
http://www.forexfactory.com/showthread.php?t=95721

I trade this method on live for a while already. Still profitable.
I'm going to look at this thread in some depth; does it seem that he trades the hedge in a bit of a directional manner?
Quoting Dreamliner
I'm going to look at this thread in some depth; does it seem that he trades the hedge in a bit of a directional manner?
It actually takes allot of reading and re-reading to get your head around what he is actually doing. But it does work, if you apply and stick to the rules.
brucech asked me in PM about my excel file I've used to pair trading calculation (I wrote about it sometimes ago In Zeusjoes thread).This remind me about FF forum and I decide to do something
I don’t have this excel file but I created new one for him. But it demand some description.

I sent it to him and think maybe someone else will find it interesting too.
I attach file about my methods of statistical arbitrage trading (pdf) and excel file one could use for some pair trading calculation.
Generally speaking I test pair behavior in some testing period, set model parameters and trade in next period.

I don't use MT4 to pair trading so I don't have indicators or EA and I don't use Excel - I'm using mainly matlab.
Because of my actual projects I haven't too much time and unfortunately seldom visit FF.

Regards,

Andrew
Attached File(s)
File Type: xls Pair.xls   884 KB | 1,507 downloads
File Type: pdf pairtrading.pdf   127 KB | 9,669 downloads
What would be the benefit of trading the hedge in this way, as opposed to just trading EUR/CHF in the direction it is trending?

Quoting scooby-doo
By the way, I wasnt trying to knock down this methodology or thread. But, if you wish to hedge then try the following when a new bar begins on the daily timeframe...

For negative correlated pairs. <= -0.8

IF, EURCHF is trending upwards

BUY 1 Lots of EURUSD
BUY 1 * EURUSD/USDCHF Lots of USDCHF

IF, EURCHF is trending downwards

SELL 1 Lots of EURUSD
SELL 1 * EURUSD/USDCHF Lots of USDCHF

Close out for profit or loss just before the end of the day. Now, how do we know EURCHF is trending in either direction...

IF EMA25 EURCHF > EMA50 EURCHF...
Quoting Dreamliner
What would be the benefit of trading the hedge in this way, as opposed to just trading EUR/CHF in the direction it is trending?
1. Because of the EURUSD/USDCHF relationship, you use less leverage/margin when opening both trades together.

2. Yes, i know, you end up paying double the spread. But because of their correlation relationship, the two trades hedge each other so that drawdown is relatively allot lower. This allows you to have the two trades open for several days if need be.

3. EURCHF is a well known RAINGING currency. So, it can trend up past its mean and vice versa. If you get the trend direction wrong, then, normally it would be bad news if trading a single currency. Using it as a reference point to trade EURUSD and USDCHF together allows you a great deal of latitude.

Anyway, dont take my work for it. Try it for yourself. But remember the golden rule i stated. Check what USD is doing with regards to economic/news releases.
Thanks for this Andrew. Very interesting. Essentially what I'm (attempting to)implement, except I couldn't manage the fancy maths

Now I can see and understand the formulas in you Excel sheet, which is going to be very helpful.

All the best
John
This makes sense. Would you be willing to start a new thread with this strategy so we can all do our testing and post results?

Quoting scooby-doo
1. Because of the EURUSD/USDCHF relationship, you use less leverage/margin when opening both trades together.

2. Yes, i know, you end up paying double the spread. But because of their correlation relationship, the two trades hedge each other so that drawdown is relatively allot lower. This allows you to have the two trades open for several days if need be.

3. EURCHF is a well known RAINGING currency. So, it can trend up past its mean and vice versa. If you get the trend direction wrong, then, normally it would be bad news if trading a single...
Can someone write mt4 indicator based on the formulas Andrew_e posted?
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