What's the point of hedging? | Forex Factory

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What's the point of hedging?

  • #1
  • First Post: Jan 24, 2010 10:57pm Jan 24, 2010 10:57pm
I have been reading numerous posts and article on this topic lately trying to understand the true benefits of hedging, but i still don't get it and see it as a pointless exercise.

Here what i have gathered and understood so far:

1) Hedging reduces risk.
Typical example given: You think EUR/USD will go up, so you long 50 Lots, Short 30 Lots to "hedge position" and if your wrong you will have lost less.

****My understanding - Why not just go Long 20 Lots since the net position is +20, yes you lose less, but you also gain less if it goes up, why not just take a smaller position to start with?

2) Hedging with two inversly correlated pairs
Example: Long EUR/USD Long USD/CHF

****But isn't this similar to just trading EUR/CHF?

3) Other examples i have heard are

"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."

***Isn't this the same as just closing the position? Why not just come back and resume the trend with a new trade? Its not like your making any money in the meantime that your hedging

My understanding of hedging is "opening and closing trades such that you reduce risk because in actual fact your just reducing your position, hence also limiting profit"
  • #2
  • Jan 24, 2010 11:27pm Jan 24, 2010 11:27pm
Quoting BobbyBob
I have been reading numerous posts and article on this topic lately trying to understand the true benefits of hedging, but i still don't get it and see it as a pointless exercise.
I likewise see it as pointless, at least mathematically.

Being hedged in the same pair can always be replicated by a single, net position. However, some traders might find it more convenient to place offsetting pending orders, and then walk away, rather than babysitting the trade exits. The hedged trader will pay more swap (if positions are open at 1700 NY EST) than the trader who is simply out of the market, and also possibly more spread, depending on the number of positions opened. There's a good thread here (the linked post is a fair summary, IMO), on the pros and cons of 'nedging'.

As for being long in both X/Y and Y/Z as being the same as being long in X/Z, that's also true, unless there's an inefficiency that allows 'triangular arbitrage'.
  • #3
  • Jan 24, 2010 11:53pm Jan 24, 2010 11:53pm
Quoting BobbyBob
but i still don't get it and see it as a pointless exercise
You are correct, it is completely and utterly pointless.
Hanover has written many long and eloquent posts explaining the futility of 'nedging', only to get a bunch of crap back from idiots.
The one positive spin-off from all the utter bullshit written on this forum about hedging is that it allows one an easy way of building a good ignore list.
The breaking of a wave cannot explain the whole sea.
  • #4
  • Jan 24, 2010 11:55pm Jan 24, 2010 11:55pm
Oh thanks for that link.. So its just some convoluted term that people throw around to make themselves sound smart when in actual fact its pointless.
  • #5
  • Jan 25, 2010 12:09am Jan 25, 2010 12:09am
Quoting BobbyBob
I have been reading numerous posts and article on this topic lately trying to understand the true benefits of hedging, but i still don't get it and see it as a pointless exercise.

Here what i have gathered and understood so far:

1) Hedging reduces risk.
Typical example given: You think EUR/USD will go up, so you long 50 Lots, Short 30 Lots to "hedge position" and if your wrong you will have lost less.

****My understanding - Why not just go Long 20 Lots since the net position is +20, yes you lose less, but you also gain less if it goes up,...
Hedging is all but useless.. I do it daily and couldnt survive without it... altho in the since you are using it in.. it is not hedging.. shorting and going long in the same position is quite pointless unless the position rattles around in consolidation like no ones business... then i guess it is worth looking at buy still i wouldnt bother..

Real hedging is placing the right orders in the right vehicles to be market neutral or near market neutral.. For example... going long Lowes and short Home depot.. so if the market rises in theory the strongest stock will lead. and the weaker will sit or slightly rise .. but if the market falls the stronger stock will move slightly and the weaker will fall much faster... This is the trader since in hedging..
Companies look at it different.. They look to hedge prices against future prices to give them a competative advantage in the market place..
for example Southwest airlines...they hedge fuel costs for the future to beat other airlines.. they hedge in oil so that when price goes up they are still paying for past prices.. when everyone else is paying higher prices.. this gives a competative advantage..

now in currencies you can hedge currencies against currencies as u will be bias im one way or another... but if you can find something outside of currencies to hedge a pair with it can be helpful to reduce risk.. for example.. shorting gold or something else and long aud/usd .. if aud rises and usd drops youll make money in aud/usd and u will lose money in gold because as the dollar drops gold will generally increase in value against it. But if youve looked into the hedge and decided that if the aud/usd rises and gold rises youll make more by being long in aud/usd and short gold than youll lose then youve got a good hedge.. and if you decided as well that if the aud/usd long and short gold falls.. youll make money in gold and loss in aud/usd will be offset.

Some people consider holding a basket to be hedging but its not... a carrying basket is considered diversification not hedge.. you are simply looking at fundamentals judging the overal market and spreading risk with fundamentals.

anyways general enough.. sorry i dont have correlation tables and stuff for you to make better examples. good luck

edit: generally tho make sure the base on the 2nd hedge doesnt match the first as all prices are relative so even if ur trying to hedge a or youll have to much exposure and its not a good hedge
  • #6
  • Jan 25, 2010 12:26am Jan 25, 2010 12:26am
The only valid point in hedging on the same currency pair, would be while taking short term counter-trend trades on the retracements and conserving a longer term trend trade up to its ultimate target, while protecting the profits already made.

In my own experience, hedging as protection only works if you are protecting a profit, but can be a tragic mistake if you use it to salvage a loss. Un-hedging at the right moment requires perfection in picking the right turning point... and even if you do it right once, twice or ten times in a row, the eleventh can bring your equity down much further thus forcing you to hedge again, try to unhedge later on, etc etc...

The first time I did it I had no idea about the nightmare that it could become. And I didn't listen to more experienced voices that warned me against it. Thereafter, I did it on purpose to try to prove that it could be possible to recover a loss through hedging and unhedging... the only benefit I got of this was to develop a keener eye for reversals, but even a one-in-ten inaccuracy can bring you down to the dreaded margin call, which in fact it did, twice, on the test accounts. 100% perfection is impossible to achieve.

It would eventually work with an unlimited capital or extremely low leverage... but what for? It is much better to take up the loss, and move on to the next trade.

As to hedging by going long on inversely correlated pairs, I think it is totally different; people usually try to benefit off the differential that can be obtained when one of them behaves with more volatility, though honestly I have no experience doing it.
  • #7
  • Jan 25, 2010 12:39am Jan 25, 2010 12:39am
i only hedge when i lookin for reversal..
  • #8
  • Edited 12:55am Jan 25, 2010 12:44am | Edited 12:55am
its not hedging..... thats an exposure buffer

buffering mid term gains with long term ones.
  • #9
  • Jan 25, 2010 1:09am Jan 25, 2010 1:09am
Quoting domino
Real hedging is placing the right orders in the right vehicles to be market neutral or near market neutral.. For example... going long Lowes and short Home depot.. so if the market rises in theory the strongest stock will lead. and the weaker will sit or slightly rise .. but if the market falls the stronger stock will move slightly and the weaker will fall much faster... This is the trader since in hedging..
Heres how i see it. potential risk% is reduce (i.e less profit/risk) however a larger capital is used to enter position of buying into two companies

Why not just buy into one company with a higher risk% (i.e more profit/risk? in the end the $$$ will be the same.

eg: larger capital x small % = Smaller capital x large % (assuming strength correlation between companies remains constant, if not, then your just trading the strength correlation and speculating which company will be better off)

Quoting domino
now in currencies you can hedge currencies against currencies as u will be bias im one way or another... but if you can find something outside of currencies to hedge a pair with it can be helpful to reduce risk.. for example.. shorting gold or something else and long aud/usd .. if aud rises and usd drops youll make money in aud/usd and u will lose money in gold because as the dollar drops gold will generally increase in value against it....
Pretty much the same example as above... why not just trade AUD vs GOLD?
  • #10
  • Jan 25, 2010 9:20am Jan 25, 2010 9:20am
Quoting BobbyBob
2) Hedging with two inversly correlated pairs
Example: Long EUR/USD Long USD/CHF

****But isn't this similar to just trading EUR/CHF?
I would add that in fact, it would be similar to trading EUR/CHF both sides (long and short), as you'll profit on the stronger currency, whichever it be.
  • #11
  • Jan 25, 2010 9:39am Jan 25, 2010 9:39am
I've never done hedging , but it seems that it could be effective for grabbing some pips during a slow market time. Say you have a day where the us/chf is ranging a few pips up and a few pips down. You place your hedge going short and long..when your up in one position 6 or 7 pips, you close that position. Then, if the other open position comes back to even or gains a few pips, you then close that position. In a slow ranging market,with enough lots, seems you could do well.
  • #12
  • Jan 25, 2010 3:31pm Jan 25, 2010 3:31pm
LOL, here we go again........
  • #13
  • Jan 25, 2010 3:35pm Jan 25, 2010 3:35pm
hedgeing is important , many financial companies use it so it cannot be useless . The only reason people say its useless is because they dont know the math and how to use it successfully
Hate what you don't understand >>>
  • #14
  • Jan 25, 2010 4:31pm Jan 25, 2010 4:31pm
Quoting DavidValera
hedgeing is important , many financial companies use it so it cannot be useless . The only reason people say its useless is because they dont know the math and how to use it successfully
Hate what you don't understand >>>
Financial companies implement what are known as 'dollar neutral' or 'market hedged' strategies, this is completely different from going long and short at the same time in some sketchy bucket shop playpen. If you are mixing these two up then I suggest it is you who may want to do some more 'understanding'.
The breaking of a wave cannot explain the whole sea.
  • #15
  • Edited 5:18pm Jan 25, 2010 4:47pm | Edited 5:18pm
Quoting BobbyBob
Heres how i see it. potential risk% is reduce (i.e less profit/risk) however a larger capital is used to enter position of buying into two companies

Why not just buy into one company with a higher risk% (i.e more profit/risk? in the end the $$$ will be the same.

eg: larger capital x small % = Smaller capital x large % (assuming strength correlation between companies remains constant, if not, then your just trading the strength correlation and speculating which company will be better off)



Pretty much the same example as above... why...


your missing the point... your spreading exposure yeah youll have less rewards and less risk but your risk adjusted reward will be much higher and its much safer than making the same profits with less exposure in one thing.

The main reason for better risk adjusted reward is the ability to amplify profits through leverage if the risk is safer.. you can rescale the risk to be the same with much larger reward... its efficiency...
  • #16
  • Jan 25, 2010 4:48pm Jan 25, 2010 4:48pm
Quoting Craig
Financial companies implement what are known as 'dollar neutral' or 'market hedged' strategies, this is completely different from going long and short at the same time in some sketchy bucket shop playpen. If you are mixing these two up then I suggest it is you who may want to do some more 'understanding'.
correct ... especially the same currency its not even hedging....
  • #17
  • Jan 25, 2010 5:36pm Jan 25, 2010 5:36pm
Hi Bobby,
i think better u try it for yaself..if u ask A person he will give u A answer if u ask B person he will give u B answer..u will find ya answer if u find it not suitable with ya trading style..
  • #18
  • Edited 7:18pm Jan 25, 2010 7:03pm | Edited 7:18pm
Quoting Craig
Financial companies implement what are known as 'dollar neutral' or 'market hedged' strategies, this is completely different from going long and short at the same time in some sketchy bucket shop playpen. If you are mixing these two up then I suggest it is you who may want to do some more 'understanding'.
well sir I hedge and make a good living of it i'm only 18 too so whatever u wanna call it thank god for it becuase it's makes me a great living , hedge working atleast for me so Idk & Idc bout the rest of the people
  • #19
  • Jan 25, 2010 7:05pm Jan 25, 2010 7:05pm
And my style of hedging isn't the way everyone describes it , I change it up a bit so I guess it's not technically hedging .. But Idc it works so I won't fix something that's not broken
  • #20
  • Jan 27, 2010 8:13pm Jan 27, 2010 8:13pm
Quoting DavidValera
well sir I hedge and make a good living of it i'm only 18 too so whatever u wanna call it thank god for it becuase it's makes me a great living , hedge working atleast for me so Idk & Idc bout the rest of the people
There is no financial benefit in being long and short in the same pair, at the same time.
 In my job, i hedge our big mineral resource sales using derivatives to lock in best prices and to give us more certainty of our future prices for our international resource sales. (i work for one of the worlds biggest mining minerals and resource companies).
We then hedge our contacts USD currency transactions into the local currencies to get the best results for our shareholders because our costs are paid in the local currencies.
That is true hedging. The posts I have seen here about hedging as using long and short transactions in the one pair at the same time is rubbish and is a dicky idea.
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