What’s the point of not allowing hedging (in the US) if it’s completely useless (I can just close the trade instead of opening trades in both directions)? Why make a big deal out of it? Is there a way to make a profit out of hedging that I am not aware of?
Hedging can certainly be profitable if used properly. See my thread: 301 Moved Permanently
I think the US is overstepping their boundaries by putting restrictions on what traders can do with their money. The same goes for the restrictions that are put on retirement accounts. The regulators just have a huge lack of understanding of trading.
Hedging is allowed in the Forex trade but you need to know the best use of it, you can not make well if you have not learn it so you need to learn it before use it.
Thanks for the replies. But I still don’t understand why anyone would have the need to hedge using the same instrument. Can’t he just close the existing position? 100 units long, plus 100 units short, gives a net of zero units. So why not just close the 100 units long? Isn’t that also a net of zero units?
The point is he can’t close the position because he expects to profit from it. And using hedging he gets the opportunity to wait out the bad period or decrease risk towards returns.
For example I use BO optiontrade to hedge some of my forex trades.
Ding! Ding Ding! Nailed it.
“Hedging” is nothing more than an accounting variation. Despite the claims of some, it’s simply impossible to profit from it. You can’t create a profit by rearranging the order in which you record entry and exit points in your ledger.
I always thought it was borderline criminal (certainly unethical) how some brokers actively promoted “hedge” strategies.
Exactly so.
Needless to say, you should be concentrating on Rhodytrader’s reply, just above (rather than some of the ones higher up the page!). 
Yes hedging in the spot forex market is and always will be pointless. Infact most of the people I see that use a hedge strategy are usually trying to sell something either a signal service or a trading course. By using a hedge these people can show long steaks of never losing a trade. So the uninformed newbie looks at the track record and thinks damn this guy is the real deal. But I have never seen it actually bring profit over the long term and eventually you blow up the account or get margin called because use have way to much exposer to the market and not enough capital.
As stated above it is best to just get out of a trade instead of hedging it. In the case of profitability stated “The point is he can’t close the position because he expects to profit from it. And using hedging he gets the opportunity to wait out the bad period or decrease risk towards returns” makes no sense as why decrease risk when you can eliminate it during “bad periods”. Also by closing the trade in bad periods you can just reenter later at a better price.
Now I do agree that the CFTC is over stepping there bounds if someone wants to hedge let them. Its there money. They do allow hedging in the USA but you have to have very large capital and to be honest those are the one who needed to be regulated.
FIFO well thats just a crap rule to prevent hedging and it does but some limitations on how you can trade as if you have a long term investment strategy and say a scalping strategy you can be limited with FIFO on trading the same asset.
Honestly it has nothing to do with protecting the little guy they could care less about you and me. Its about power and always will be with government agencies.
Thanks people!
So I’m not sure which quote to respond to because there seems to be a lot of misunderstanding here (and I am surprised because there are FX men commenting (i.e. the same lack of understanding that the regulators have on hedging)).
First of all, you CAN certainly be profitable hedging, if done properly (as i stated previously and as I am proving with my strategy that I portray in my thread). Everyone here is assuming a 100% hedge on the original position, but there are other ways to hedge! It’s actually very simple! Let think outside the box people!
If you are long a position and you put a hedge on it that is smaller than the original position and take a profit on the hedge, you have very effectively reduced your cost basis and therefore have increased your profitability of making money on that original trade. Do I need to explain more?..
No institutional player uses this form of “hedging” where offsetting positions are shown as being open rather than netted out. If you talk with anyone at that level and try to explain this retail forex idea of hedging they look at you like you must be pulling their leg.
FIFO well thats just a crap rule to prevent hedging and it does but some limitations on how you can trade as if you have a long term investment strategy and say a scalping strategy you can be limited with FIFO on trading the same asset.
Honestly it has nothing to do with protecting the little guy they could care less about you and me. Its about power and always will be with government agencies.
FIFO is IRS tax policy. Always has been. It’s that simple.
This is what I call misattribution, which can be very dangerous.
Profitability is based on where and when you put on and take off exposure to price action - and in the case of a partial “hedge”, by how much (there was no assumption of 100% hedging). You would have EXACTLY the same results (possibly even better when factoring in potential added costs) by closing that part of your position you are “hedging” rather than putting on an offsetting trade. “Hedging” is NOT a strategy. The strategy is the set of rules or analysis you use to time your buy/sell decisions. The proof of this is in the fact that any so-called “hedge” system can be replicated in a non-hedge fashion.
FIFO and hedge accounting are just two different ways of keeping track of your trades and returns. The result of both is the same. FIFO is better because it lets you see your actual current exposure to the market and it doesn’t let you fool yourself into thinking you’re doing better than you are by creating an artificially inflated win rate.
Exactly so. Thanks for correcting the persistent misleading “information” in this thread, Rhodytrader.
Misattribution? LOL. Don’t call it that! People are definitely going to misinterpret my point when you say it like that.
There is no misattribution going on here. The cost basis reduction of taking off a winning hedge trade is REAL. Just in the same way of lowering your cost basis by adding to an existing position at a better price. Just because the net result of hedging versus dollar cost averaging may be the same, doesn’t mean that the effect of the hedge isn’t real. Your comment is the same as saying that cost basis reduction from dollar cost averaging isn’t real.
And cmon, Lexys! If you are going to hop on the bandwagon, say something meaningful.
To show that hedging can be the same as dollar cost averaging here is an example:
1.Long 100 Shares at $100, Sell 10 shares at $0 profit = Net Long 90 Shares at $100; Account Value is $10,000, Cost basis is $100
2.Long 100 Shares at $100, Short 10 shares at $100 = Net Long 90 shares at $100; Account Value is $10,000, Cost basis is $100
Price Goes to $95
1.Long 90 shares at $95, Net loss is $450 (90 shares at $100 - 90 Share at $95), dollar cost average in with the buying power of the original trade taken off to make cost basis $95.50. Net result is $100 shares long at $95 with cost basis of $99.50
2. Take profit at $95 on the hedge, Net Loss is also $450 ($50 profit taken off from the hedge), and now the net Result is long $100 shares at $95 with a cost basis of $99.50.
When you say that hedging is not a strategy, you are really splitting hairs here. Regardless of whether you can execute the same strategy in a “non-hedge fashion” are you saying then that the “non-hedge fashion” strategy is not a strategy? Doesn’t make any sense. It is just as much as a strategy as dollar cost averaging is.
There are certainly tax benefits to using a hedge versus closing out a trade. If you have a low cost basis on a position and you want to lock in a profit but not incur any large taxable gains, throw a 100% hedge on it! You can ride out any down moves and then pull the hedge off when you think there is more upside potential.
Also, I prefer to use a hedge because my main risk is getting blown out by a large move in one direction. I am not able to watch the markets at all times so I can benefit from keeping my core position smaller and the hedge helps neutralize that. I can reduce my directional risk by hedging.
4give this young lad. He thinks his demo account with metaquotes makes him an authority on hedging/ dollar cost averaging or what not , bla bla bla. Bronze, you have gotten to much sun, best you do some research on some of the members here. They are not all civilians like me.
You might not understand dollar cost averaging properly. When you do that you are [I]adding[/I] to your position. Yes, you do it at a lower price, thus reducing your average cost, but you are [I]increasing[/I] your market exposure. (And by the way, the IRS requires FIFO accounting when you report your gains/losses).
With a hedge you reduce or eliminate your risk.
To show that hedging can be the same as dollar cost averaging here is an example:
1.Long 100 Shares at $100, Sell 10 shares at $0 profit = Net Long 90 Shares at $100; Account Value is $10,000, Cost basis is $100
2.Long 100 Shares at $100, Short 10 shares at $100 = Net Long 90 shares at $100; Account Value is $10,000, Cost basis is $100
It looks as though you think #1 represents dollar cost average, since #2 is clearly a hedge. All #1 is, however, is cutting your position, which functionally is the same as #2.
Price Goes to $95
1.Long 90 shares at $95, Net loss is $450 (90 shares at $100 - 90 Share at $95), dollar cost average in with the buying power of the original trade taken off to make cost basis $95.50. Net result is $100 shares long at $95 with cost basis of $99.50
2. Take profit at $95 on the hedge, Net Loss is also $450 ($50 profit taken off from the hedge), and now the net Result is long $100 shares at $95 with a cost basis of $99.50.
If you bought shares at $95 here (added to your initial position), that would be dollar cost averaging. But you haven’t, so it isn’t.
Are you reducing your cost basis? Certainly in the first case the answer is No. You reduced the size of your market exposure, but you didn’t change the average price at which you purchased your shares.
How about in the second case? Maybe, but I’m not sold on that idea - at least in the way you seem to be thinking about it.
When you say that hedging is not a strategy, you are really splitting hairs here. Regardless of whether you can execute the same strategy in a “non-hedge fashion” are you saying then that the “non-hedge fashion” strategy is not a strategy? Doesn’t make any sense. It is just as much as a strategy as dollar cost averaging is.
A trading strategy is a set or rules or guidelines or whatever you call it which drive your decision to buy at one price and sell at another. Let’s use a simple moving average cross-over system as an example. The strategy is to buy when price crosses above and sell when price crosses below. You could use FIFO accounting or you could use “hedge” accounting to record your actions. By that I mean when you have a long position on and get a sell signal you can either sell to close the long (FIFO) or you can keep the long open and initiate a short (hedge). The bottom line is that in both cases you buy and sell at the same prices, your exposure is the same, and your profitability works out the same (excluding any potential added cost from the hedge transactions). Your performance is driven by the buy/sell signals from your strategy, not by whether you use FIFO or hedging.
Dollar cost average is a strategy in that you have (hopefully) rules for when you add to your position.
Hedging is the result of the buying and selling you do based on the strategy you use.
This is where misattribution comes in. When you evaluate the performance of your strategy - where you buy and where you sell - you want to do it based on a clean indication of where those signals came. Hedging muddles that.
Say you go long at 100. The market goes against you, so you put on a hedge at 95. The market drops to 90 and you close the hedge. The market returns to 97. You close the original trade. You’ve got a net profit of 2. You’re down 3 on the original position, but made 5 on the hedge.
If you did this in a non-hedge fashion you would have closed the original trade at 95 and re-entered long at 90.
When you do an after-action performance assessment, what do you say?
You should be judging your strategy’s performance based on the initial entry signal, the signal you got saying you don’t want to be long anymore (or at least want to reduce exposure), the signal to once more have full exposure, and finally the signal to exit the market. It could be argued that you basically have two entry-exit sets of decisions there, each of which should be evaluated separately. People who use “hedging” seem to think of this as two decisions (enter initial position, close initial position) and don’t properly view it as a potentially lengthy sequences of decisions (hopefully based on signals from their strategy). Each one of those decisions (signals) needs to be evaluated, however.
There are certainly tax benefits to using a hedge versus closing out a trade. If you have a low cost basis on a position and you want to lock in a profit but not incur any large taxable gains, throw a 100% hedge on it! You can ride out any down moves and then pull the hedge off when you think there is more upside potential.
Retail forex taxes are done on a mark-to-market basis (at least in the US). That means you count the gains or losses on open positions at year-end. Thus, hedging makes no difference.
Also, I prefer to use a hedge because my main risk is getting blown out by a large move in one direction. I am not able to watch the markets at all times so I can benefit from keeping my core position smaller and the hedge helps neutralize that. I can reduce my directional risk by hedging.
Closing out part of your position and/or having a stop serve exactly the same purpose.