There is a possibility that a correlation temporarily breaks down between the Forex position and the ETFs. There are different ways to approach this and help minimize that risk. Overall though in the long term it should even itself out. If you have correlation that breaks down and your hedge only partially covers your loss, in other cases you will have correlation that strengthens and your hedge will end up making profits over your loss. I will also explore the idea of splitting your hedge between 2 or 3 different stocks, that way if correlation breaks down on 1, it has an overall smaller effect on your hedge.
From reading your comment I want to make sure you understand that you purchase the option hedge at the exact same time that you open your Forex position. This way during the entire distance that your Forex position has been losing, your hedge would have been making profit. Once your stoploss is hit you would close your hedge along side of your Forex position.
I’ve been geting my head round this concept of lately and as mentioned in the earlier posts by krugman, for this idea to work the forex position must have a minimum of 1:2 risk reward to cover the hedging loss and still make profit. And for this to be attained the hedging position need to have a maximum of 1R loss so as not to offset the profit of the forex position. When the hedging position hits stop loss, it means that the forex position is in 1:1 profit which is still not profitable and should it turn against us, we are lossing double position.
Any idea or concept as to how to manage a trade attaining a minimum of 1:2 reward in forex position and a 1R loss in the other hedging position?
Hope you are having a good weekend…just been thinking through this castling a bit more…
Given you can minimise the risk of the correlation temporarily breaks down or it evens itself out, does this mean you can risk more per trade than you would if you hadn’t hedged? I mean what’s to stop you from risking as much as 5%, 10% or more [shudder] per trade?!