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"Hedging" Revisited

  • #1
  • First Post: Nov 8, 2010 2:47pm Nov 8, 2010 2:47pm
First let me pose a question then qualify it with certain "definitions".

What's wrong with "hedging" the forex market? By that I mean, taking opposing position in the same market at the same time?

Of course I wouldn't do it recklessly or indiscriminantly, but I believe there is a solid basis for doing this and have 3 years of hard data to back up my assumptions.

Using price action signals or candlesticks it is clear that this method has value but fall short (as does every other method) on picking direction early enough to catch a change in directional bias (read "trend") until its too late. Thus why not take a trade in which ever direction the market indicates regardless of the "wiser minds" who say, "...the trend is your friend..." and any other host of cliche catch phrases meant to keep you on the wrong side of the market.

Example trade: long on (pick your pair) on a daily price action signal, hammer or piercing line. Hold trade until an opposing price action signal, say a dark cloud or shooting star. At the opposing signal close 1/2 the long and enter a short. If the short signal confirms close out the rest of the long and hold the short until the next opposing (this time long) signal. Rinse...repeat until rich.

Using this idea (with a few refinements) I have been able to show significant gains over the course of the last three years. Most each year doubles the account or comes very close to it (90% gain), with only 1% risk in each trade.

So someone tell me what's wrong with this method of trading, or am I just so stupid I've only recently figured it out.
  • #2
  • Nov 9, 2010 2:40am Nov 9, 2010 2:40am
There's nothing wrong with the idea but you don't seem to know why you're profitable.

You are profitable because you trade till the market goes in your direction long enough to cover the previous small losses and you've tested during an unusually trending period.

Your system is not a proof that hedging the same pair puts the odds in your favor. The way you trade would also be profitable if you'd close completely the losing positions when the price action signals a change of direction. You simply have more right signals than wrong ones, that's all.
  • #3
  • Nov 9, 2010 3:04am Nov 9, 2010 3:04am
Quoting gspajon
So someone tell me what's wrong with this method of trading, or am I just so stupid I've only recently figured it out.
Has the checkout boy ever asked you how you made the money you're spending at the shop? No? Then don't worry about that, just make sure it's legal.

It's OK if you feel comfortable with that way of trading, and you're making money without horrible DDs on the longer term. After all, it's your funeral.
forget about tomorrow, just steal away into the night
  • #4
  • Edited 3:42pm Nov 9, 2010 3:44am | Edited 3:42pm
There's nothing inherently wrong with 'hedging' (in the same pair). It's just that exactly the same pips can be captured without hedging, and with less costs (swap and possibly spread).

Why? Because every hedged position ultimately resolves itself into either being net long, net short, or net flat, at each point along the way. Net long or short can always be replicated by a single position, and net flat has the same effect as being out of the market altogether. (Merlin offered $100k to anybody who could devise a hedge strategy that couldn't be replicated without the hedge).

Because br0kers tend to charge more swap on non-carry-trade-directional positions than they pay on carry-trade-directional positions, it is cheaper to be out of the market altogether, than paying the swap differential. And depending on how the hedge operates, it can sometimes be cheaper spread-wise, to be non-hedged than hedged, but never the other way around (example here).

Profit is determined by the magnitude of which you're net long when price is rising, and net short when it's falling. Hedging, scaling in/out, OCOs, TPs, SLs, entries are effectively nothing more than adjustments to your overall net position. How accurately you make these adjustments relative to market reversals determines your P/L, and is therefore a strategy issue. But how you go about placing the orders is ultimately nothing more than an operational issue.

Viewed in that way, a strategy can provide an edge, but a same-pair hedge can't. However, assuming you're willing to pay any extra costs that might be involved, a hedge may be the most convenient means of placing the orders needed to implement a given strategy.

Footnote: here is a good thread on the pros and cons of hedging, with its conclusions posted here.
  • #5
  • Nov 9, 2010 5:46am Nov 9, 2010 5:46am
I can say that hedging is a good way to make up for inaccuracies in your system. However, it will only do this if employed properly.

The cost of employing such is muted if the method is profitable. Because you are opening these trades to "off-set" risk. The cost is needed to make it work because the edge of system is lost under certain market conditions.

If you spend too much time on cost... opening or not opening a trade then you will never get anywhere. There are other ways to skin the cat so to speak.

Hedging in my mind is just a tool and if you use it improperly it becomes a weapon of mass destruction to your trading account. At one point in time I thought there was no other way to get around the need to hedge, but that has since changed. I can tell you it's nice to have it in the tool bag in the event such a scenario presents itself.

I have often called it my "check mate" move for the market. I haven't needed it tho in a long, long time now. So there are other ways, but I don't sit there and say wow I saved $100 on spread costs. The bigger cost is time in the market.
  • #6
  • Nov 9, 2010 9:17am Nov 9, 2010 9:17am
Thank you for your replies everyone...

I disagree with some comments however.

Souron, "You are profitable because you trade till the market goes in your direction long enough to cover the previous small losses and you've tested during an unusually trending period." Yes the first part of your statement has some truth, however, as to an "unusually trending period", if this is true then the last 10-15 years would also apply as an unusually trending. My study of the EUR, AUD, GBP, CHF all bear out that these kinds of trends are common. Granted the most recent geopolicital events have been uncommon and this has lead to an acceleration of these trends but they are not unusual or uncommon.

Hanover, "Because br0kers tend to charge more swap on non-carry-trade-directional positions than they pay on carry-trade-directional positions, it is cheaper to be out of the market altogether, than paying the swap differential." Admittedly I did not take the swap into account because it was virtually impossible to know the swap on a day to day basis going back over the past several years. I suspect this may pull profits down some but not significantly. Average time in trade is working out to be anywhere from 3-5 days. There are some exceptions of course.

Pipseeker, "Hedging in my mind is just a tool and if you use it improperly it becomes a weapon of mass destruction to your trading account." The danger of mass destruction I off set with risk management and have a very strict set of rules based on percent of account that I use to scale out of and/or protect individual positions.

To all...The basic premis of this method is simple. No one...NO ONE can accurately or definitively state or describe a "trend", much less when one begins or ends. It is only in retrospect that we say, "ah hah", a trend started here. In my opinion that ah hah moment comes to late. By this time the bulk of the trend is under the bridge and whether or not it continues is based on your assessment tools and or ability to divine market sentiment. No matter what there is alway one axiom that comes through..."the market is always right".

Well why not put that axiom to the test. If the market is always right, then I should follow the market through out its little twists and turns. If it ranges, I make a small amount of money (<1%) on each trade and sustain losses on approximately 40% my trades. If the market trends I make a great deal of money the trending trades (2%-5%) and sustain losses on approximately 20% my trades. Considering each loss is contained to 1% or less, the method makes money over all.

Even from a math expectancy point of view the method generates an expectancy number of between 1.5 and 3.5.

Thus I ask again, what is wrong with this? Trending or ranging the method makes consistent profits. I admit I must do more back testing to include a greater sample of data however, I am encouraged by the results to date and looking back at the charts for the last 10 years I see no significant structural differences in the the general trends to make me think that this method would prove unprofitable.
  • #7
  • Nov 9, 2010 11:59am Nov 9, 2010 11:59am
Quoting gspajon
Thank you for your replies everyone...

I disagree with some comments however.


Pipseeker, "Hedging in my mind is just a tool and if you use it improperly it becomes a weapon of mass destruction to your trading account." The danger of mass destruction I off set with risk management and have a very strict set of rules based on percent of account that I use to scale out of and/or protect individual positions.


Thus I ask again, what is wrong with this? Trending or ranging the method makes consistent profits. I admit I must do more...
To shed more light on what I said about mass destruction to your account is you still have to have timing down. Because at some point you will need to close one side of the hedge. If the pair continues in the direction of the trades you closed out the hedge didn't do you any good.

So with that said you can't just blindly trade the market. Equity && Margin become your biggest sight glass as to how well or poorly you are doing.

There is nothing wrong with it, there are advantages to it provided you know and understand what you are doing... like I said above about timing. There is no free ride I can tell you that much. The hedge gives you more time to figure out what you're going to do.... as time is more on your side provided you don't over-leverage.

It's common knowledge trend is here one minute and gone the next. With the hedge you are playing the odds and time favors the trader. That's basically it wrapped up in a neat little nutshell. Impatience favors the broker /LP or whoever has the opposite side of the trade.

BTW, don't put any faith into a backtest. If there are any cracks, the market will shirley find it. And don't call the market shirley he hates it.


Shirley if I told you once I told you 1 thousand times do not do that!
Shirley you got some splaining to do!
  • #8
  • Nov 9, 2010 2:07pm Nov 9, 2010 2:07pm
Quoting pip_seeker
... If the pair continues in the direction of the trades you closed out the hedge didn't do you any good.... don't put any faith into a backtest. If there are any cracks,...
Time is everything in this business agreed. That is why I split the trade at a new signal, then close the remaining portion once the new signal confirms.

Again this is a matter of risk management, but often during a strong trend the original trade will continue after giving a "false" opposing signal. Splitting the trade allows me to continue in the original position and, more often than not, covers the additional loss and then some. Not to mention that sooner or later that opposing signal will confirm thus locking in final profits on the original trade and getting an "early" jump on the opposite direction (should it eventually work out that way).

I am current forward testing this idea on a demo account so as to iron out the wrinkles. I agree that back test data is "ideal" data and always best case scenario. But it is essential for determining if a theory is sustainable as theory before devoting precious time and financial resources any further development.
  • #9
  • Nov 10, 2010 7:39pm Nov 10, 2010 7:39pm
Hi

I am new to the rules of forex. I have a system in the stock market where I set trailing stops 2 to 4 percent in both long and short positions before a morning earnings report with 2 different brokers 1 for the long and 1 for the short. With stocks under 20 and over 5 dollars. basically the same thing as a straddle or a strangle in the options market except you get a better deal due to options being over priced for this method. Obviously you can do the same thing in the forex market (not sure if thats legal or not in forex). Just wondering if anybody thinks setting trailing stops this way in the forex for major news reports would work in the forex market.? personally i never risk choosing a side and also after the news is out you have to be fast to jump on. I never seem to be fast enough. The cool thing about this method is you don't have to worry about what the report is. After i get stopped out on one side i manually control the right side.

Any insight would be appreciated. Also is it legal to use two different brokers to hedge this way(one short and one long same currency)????
My trades are 100% profitable 65% of the time!
  • #10
  • Nov 10, 2010 9:59pm Nov 10, 2010 9:59pm
Quoting jimmyjames79
Hi

I am new to the rules of forex. I have a system in the stock market where I set trailing stops 2 to 4 percent in both long and short positions before a morning earnings report with 2 different brokers 1 for the long and 1 for the short. With stocks under 20 and over 5 dollars. basically the same thing as a straddle or a strangle in the options market except you get a better deal due to options being over priced for this method. Obviously you can do the same thing in the forex market (not sure if thats legal or not in forex). Just wondering...
Yeah it's legal... the CFTC /NFA has been smoking too much Democrat Crack. Hell you don't even need two different brokers, just have your broker open two seperate accounts.

Or better yet vote with your money and go off-shore and you can hedge in the same account plus get leverage up to 500:1.

It's your money... use it wisely. When the CFTC guarantees me ZERO loss is when I listen to them fools.
  • #11
  • Nov 10, 2010 10:15pm Nov 10, 2010 10:15pm
Quoting pip_seeker
Yeah it's legal... the CFTC /NFA has been smoking too much Democrat Crack. Hell you don't even need two different brokers, just have your broker open two seperate accounts.

Or better yet vote with your money and go off-shore and you can hedge in the same account plus get leverage up to 500:1.

It's your money... use it wisely. When the CFTC guarantees me ZERO loss is when I listen to them fools.
Cool thanks for the info and fast response.

I'd love to go offshore unfortunately i am a retail trader and cannot open an account over seas unless it is directly with a bank. I was told that over seas brokers can't allow me as an united states citizen to open an account.
My trades are 100% profitable 65% of the time!
  • #12
  • Nov 10, 2010 10:50pm Nov 10, 2010 10:50pm
Some do some won't because they are scared of poor little CFTC.

Do your homework and you can find a good number that will. I am living proof I can guarantee you that much.

Part of the loophole is that they don't advertise to US clients... you go there of your own free will.

The CFTC thinks the world evolves in a tiny little fishbowl. Since when does the internet exist in a tiny fishbowl? Seek and ye shall find, knock and it will be opened unto you.

Stop me before this turns into a sermon....
  • #13
  • Nov 11, 2010 7:41am Nov 11, 2010 7:41am
Quoting gspajon
First let me pose a question then qualify it with certain "definitions".

What's wrong with "hedging" the forex market?...

there is a problem with that. how do you be sure when the trend has reversed and you can enter in the opposite direction ? unless you are at least 90% sure (which is difficult) then all that would happen is you will close out half the position and enter in the opposite direction only for the market to reverse back and bite you in the nail ! you now find yourself incurring more losses as your half position is being engulfed by your full position in the reverse (original) direction.


interestingly i would like to know how you made this work for you. do you have any results you can post ?

cheers
  • #14
  • Nov 11, 2010 1:26pm Nov 11, 2010 1:26pm
Quoting gspajon
At the opposing signal close 1/2 the long and enter a short.
translates to: close the long completely and open a half-sized short

exposure before: +1
exposure after: -0.5
(needed order: sell 1.5)

Quoting gspajon
If the short signal confirms close out the rest of the long and hold the short until the next opposing
translates to: sell another half to make it a full sized short.

exposure before: -0.5
exposure after: -1
(needed order: sell 0.5)
  • #15
  • Nov 11, 2010 1:35pm Nov 11, 2010 1:35pm
Quoting whatfx
interestingly i would like to know how you made this work for you. do you have any results you can post ?
I DONT know when the market is going to reverse that's the whole point. If I knew that then I would just take a trade in the new direction at the soonest possible moment, and have a 1 tick stop loss.

I have developed a simple set of criteria (that I am still refining) to control the losses and let the winners run. I use price action (candle stick) signals to enter. Each signal must be preceded with a least a small run in the opposite direction, and a strict exit policy to keep a tight leash on losses. All of this is combined with a money management policy for position sizing and scaling out to lock in profits and keep winners winning.

As I am still working out the details and applying this to my data my results are still preliminary but still very encouraging. I am currently forward testing this on a demo account as well.
  • #16
  • Nov 11, 2010 1:42pm Nov 11, 2010 1:42pm
Quoting 7bit
translates to: close the long completely and open a half-sized short

exposure before: +1
exposure after: -0.5
(needed order: sell 1.5)
Not exactly. I have a money management formula that scales out !% at the generation of a new signal and leaves the rest going in case the new signal fails. If the new signal confirms the larger portion of the trade is closed and the opposite trade continues...its not like you've outlined here.

On the really good winners a total profit for one trade can go anywhere from 2.5% - 12%. The losers average between .5% - 1.25%. It is more than enough to offset the losses.

The overall math expectancy number works out to 2.5 with a win rate over the last three years of 62%.
  • #17
  • Nov 11, 2010 2:05pm Nov 11, 2010 2:05pm
Quoting gspajon
Not exactly. I have a money management formula that scales out !% at the generation of a new signal and leaves the rest going in case the new signal fails. If the new signal confirms the larger portion of the trade is closed and the opposite trade continues...its not like you've outlined here.
I have not outlined something similar, I have 1:1 translated what you wrote, lot for lot. With your more generalized requirements we can write it as follows:

Quote
scales out x% [and open 100% short]
translates to

completely close the long and open x% short

exposure before: +100% (100% long)
exposure after: -x% (x% short)
change (needed order): sell (100+x)%

Quote
the larger portion of the trade is closed and the opposite trade continues
translates to:

sell additional (100-x)% to make it a full short.

exposure before: -x% (x% short)
exposure after: -100% (100% short)
change (needed order): sell (100-x)%
  • #18
  • Nov 11, 2010 2:32pm Nov 11, 2010 2:32pm
Quoting gspajon
I DONT know when the market is going to reverse that's the whole point. If I knew that then I would just take a trade in the new direction at the soonest possible moment, and have a 1 tick stop loss.

I have developed a simple set of criteria (that I am still refining) to control the losses and let the winners run. I use price action (candle stick) signals to enter. Each signal must be preceded with a least a small run in the opposite direction, and a strict exit policy to keep a tight leash on losses. All of this is combined with a money management...
Take your time it can be done, but it's inherrantly dangerous and is certainly not for the faint of heart. Usually the big trend is what gets you because you under estimate it usually, so you have to watch margin / leverage / equity like a hawk.

You really need at least 200:1 to pull it off and 400:1 or higher would be best. If you can find a broker that doesn't charge you margin for the hedge trades it's even better [less risky for margin call].

At 50:1 forggettaboutit. You really want to demo test it thru a complete market cycle where it trends one way for a time and then reverses trend to the other side. This will certainly tell you how far or close you are to pulling it off.

Besure to keep good notes, because you will use them again. BTW, the reason you gave was the EXACT reason I used. You are on the same path, just years my junior.
  • #19
  • Nov 11, 2010 2:40pm Nov 11, 2010 2:40pm
Quoting pip_seeker
If you can find a broker that doesn't charge you margin for the hedge trades
You don't need hedged trades for anything.
  • #20
  • Nov 11, 2010 2:53pm Nov 11, 2010 2:53pm
Quoting 7bit
You don't need hedged trades for anything.

only if you don't know where price is going.
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