Hedging Strategy

I am trying to develop a hedging strategy to limit my risk in the market. I subscribe to a signal that trades Nasdaq and I have it set to be on only from 6 am - 4 pm est so I am able to monitor throughout the day; the signal is extremely profitable though the problem is that sometimes the trades are held into long drawdowns of hundreds of points.

I would like to develop a hedging strategy where if a trade goes into 20 points of drawdown I open a hedge trade in the opposite direction to keep the drawdown at this level. I was thinking that I would hold this trade into a key level and when it seems to reject I would take profit and then open a new trade back in the original direction for a better entry, this way the original trade can recover and the new trade will gain more profit as well.

Can anybody perhaps provide some feedback as to how successful this hedging might be in the way I plan to use it? Thanks!

Something like this?

Yes, that is the basic idea… but I was hoping someone experienced with hedging might tell me how successful it’s been for them and what techniques they use when hedging.

Really my question is would it be a good idea to open a new position when the market seems to be reversing back in your favor…

Hedging like this is a very human reaction to the pain of a losing trade, but it’s inappropriate. Eventually you have to decide to close the losing trade, which could be either the original long or the hedging short. Long-term it is no less economical and certainly more efficient to just set a stop-loss, take the loss and re-position for the next trade.

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Hedging will pause the P&L so that you can resume at another key level. Just keep in mind trading costs (commission, spread).
Plan the trades and back test them. I’ve seen it done successfully in replacing stop loss orders with hedge order.

So I successfully used this strategy today on NAS… I had a buy that went into drawdown… at 20 pips drawdown I opened a sell which kept the drawdown at $20 while the drawdown was over 70 pips… when the sell began to reject I closed it in profit and opened another buy at that level and as the original trade recovered and the new buy was in profit I closed with 1% net profit even though the original trade was still in drawdown. I could have held for some more points but I was satisfied.

The only issue I have is what if I open the hedge but the trade continues in my original direction, should I close it immediately with small loss and open a new buy to make up for it? I am curious how those experienced with hedging handle this situation.

Thank you for the replies!!

Interesting discussion, I keep thinking there must be a flaw somewhere… My thoughts are this is a lot of work, unless you manage to automate this. You need to constantly monitor the position to enter and exit when needed. Seems also that it will only work in a trending market, with some bigger pullbacks. In a volatile market you would be in and out of trades all the time, and keeping track of P&L would be a challenge. Then again, in a trending market, you might not need the hedge. Not to mention transaction costs, if that applies, in a volatile market. Like mentioned above, a stop loss and re-enter seems like a lot less work although you might take an initial loss. Which can be offset by a lower entry and correct prediction of the direction.