Why would you try to hedge a position by taking up a position on a correlated asset? Surely, if one balances out the other, you stand to not make any profit?
As a retail trader there is no reason to really hedge unless you aren’t fully confident in your trades or haven’t fully analyzed your trades. Now banks, hedge funds, option writers and buyers, large participants, etc have a totally different reason to hedge to minimize risk.
One reason I can see to hedge is if you apply your trading rules to different timeframes. You could have a long order opened following a daily upward trend for exemple, and be selling the shorter timeframes during dips applying the same trading rules to the M15 chart.
But I think mostly people hedge for psychological reasons.
I can see where your coming from but in the case of Equities, hedging long and short positions is simply prudent. Hedge funds do this as a matter of course so as to not get over exposed either way. FX is somewhat different. The only reason one might hedge for example is if your trading two highly correlated pairs (if that’s your strat). Other than that, I can see no logical reason to hedge. :58:
Hedging is also necessary when you perceive a bad/negative turn in the market while you have an opened position. I this case, you can quickly open an opposite position, either with pending or direct order. In my opinion this is the only reason to hedge. Most brokers don’t allow hedging, especially the market makers. I asked Profiforex if this is allowed and they said yes. When the time comes I will fully utilize this.
I never understood this type of hedging spygirl. Why not just close a position and open another one? How will the hedging you describe be a better option? You’re paying more (commissions and spread).
Hedging in general is a much more complex concept and mandates the use of 1 or more pairs or instruments to the one you are hedging. For example buying USD/JPY and selling Gold, or Nikkei CFD. Not buying and selling the same pair. This is only ever useful in a certain type of news spike trading, and that is why many MM’s don’t allow it.
Most traders do not understand hedging and I always shiver when I read someone opening a buy and sell in the same currency pair at the same time. Those who do not see the benefit are best advised not to hedge their positions. I do hedge my positions when necessary.
I’m honestly not claiming to understand how one may hedge a position, but I’d be sincerely grateful if you were to briefly explain to me when and how it is done? Or point me in the direction of an easy to understand article on it?
In particular, how is hedging a position any different to just trading smaller lot sizes? I mean, when hedging, you’re losses are reduced, but so are your gains - the same result as using smaller position sizes?
Thanks
Being mechanical, my rules sometimes means that I end up with hedged positions, usually happens once in a blue moon and usually during a ranging market when neither bulls are bears are winning. What normally happens after the two positions are opened is that one of the 2 trades will become the loser and the other will become a winner, eventually. I have calculated that the RR ratio of the winner will exceed the loser and that’s fine. My risk/money management ensures everything stays okay.
If you are trading discretionary and are considering hedging, sometimes it’s best not to take the trade if you are unsure of the direction.
Firstly note that CFTC compliant brokers will not allow hedging on the same currency pair. BUT, no one minds smart hedging. That’s where the correlation comes in,
From the chart above, note that the pairs have an almost perfect negative >95% correlation will move on opposite side almost all the time. ( Figure out what to buy/sell)
You wanna hedge and comply with the rules at the same time, using such pair will be your best bet.
They do allow hedging, but if you read their client agreement, you will find the rules guiding such move. By the way, your method of hedging as you have described is applicable when partly closing a position. Hedging is so complicated.
Black–Scholes model - Wikipedia, the free encyclopedia
I watched an interesting documentary on this a while back. They hedged options purchases with their traditional asset price and it worked quite well but they ended up going bust because they thought their system was perfect but it wasn’t being academics they thought they were smarter then everyone else I suppose. Google trillion dollar bet it comes straight up on youtube.
There are different strategies and way/reasons why traders hedge. For example you enter a long EURUSD, but it corrects and you hedge it. Now your losses are locked in, as it keeps dropping your long increases losses while your short earns you money. Once it approaches support you may decide to close your hedge for a profit leaving you with losses from your long which will be reduced as the currency pair does move higher. This is a very simple example, but in order to hedge successfully you need to understand how to trade. You don’t have to hedge the same currency pair which is a very big misconception among newbies. Take a look at what Grix shared.