Hey folks are any of you familiar with cross hedging. That is using two pairs that either have a very positive or very negative correlation to hedge each other.
An example might be going Long 1 lot on EURUSD and Long 1 Lot on USDCHF. They have a strong negative correlation with one another so in theory, when one pair is winning the other should be losing by roughly the same amount: assuming correlation ~ -1.
Application.
I want to us the cross hedge as a risk management application for Carry Trades. At the moment I am looking at USDMXN (Short) as the Lead Carry Trade pair, with EURUSD (Short) to hedge it at a ratio 1:1.
The 2 pairs are inversely correlated on average at -0.6 in the M1 candle. And EURUSD also happens to have a position Swap on short trades, so there is double benefit in using it this way.
So far I have written an indicator that seems which shows that with a 1:1 Short:Short pairing on USDMXN and EURUSD; the combined PnL on both pairs will oscillate between 0 several times every hour. That is EURUSD (PnL) + USDMXN (PnL) ~ 0 multiple times every hour, irrespective of how long you hold the positions.
What are your thoughts or do you have experience on cross hedging.
Cheers