Hedging is identified as a “feature” to consider when choosing a broker. Why so?
What is the benefit of the feature? Can anyone post a sample of how it works?
Thank you.
its when you buy and sell the same currency pairs at the same time.
Hedging strategies can become very complex. Let’s look at the simplest possible example.
Let’s say that you are a swing-trader, and you are SHORT a particular currency pair. You took this SHORT position three days ago, looking for a 500-700 pip move to the downside. Your position is currently positive 250 pips, and your technical analysis tells you that your profit target is still appropriate.
However, this pair has just bounced off the lower boundary line of its downward-sloping channel, and you expect a 50-100 pip upward retracement over the next 24 hours, before the down-move resumes. What should you do?
Your choices are:
[ul]
[li]hold your position, and temporarily give back 50-100 pips of your profit, expecting to recoup this temporary set-back once the retracement has been reversed
[/li]
[li]close your SHORT position, with the intention of reinstating it at a higher price after the retracement has run its course
[/li]
[li]hedge your SHORT position by taking a LONG position of the same size in the same pair, for the duration of the retracement.
[/li][/ul]
Let’s say that you choose the hedge. For the duration of the hedge, you will sacrifice additional profit, and you will avoid additional loss, because every pip gained (or lost) by the original position will be offset by a pip lost (or gained) by the hedge. This is referred to as a complete hedge, or a perfect hedge.
(Alternatively, you could hedge only a portion of your original position, and this would be referred to as a partial hedge.)
If your analysis of the market is correct, then your hedge will save you from giving back those 50 or 100 pips, while the pair retraces.
The success of this hedge depends on accurate timing. To completely insulate you from loss during the retracement, your hedge would have to be put on precisely at the beginning of the retracement, and it would have to be taken off precisely at the end of the retracement. Typically, in the real world, your timing will not be perfect.
Hedging requires the cooperation of your broker and your broker’s trading platform. That is, the platform must be configured to accept simultaneous LONG and SHORT positions in the same pair. In most countries, this is not a problem.
But, for retail forex brokers domiciled and regulated in the U.S., hedging has been banned by the National Futures Association (NFA), beginning in May 2009. If you attempt to hold simultaneous LONG and SHORT positions in the same pair with one of these U.S. brokers, your “hedge” will close all (or part) of your original position.
If you are annoyed by this sort of petty ruling by the NFA, you have the option of taking your business off-shore — you can trade through a reputable British or Swiss broker, where hedging is allowed.
That’s what I have done. And I recommend it.
Clint
Do the math and you will discover that options #2 and #3 above are [I]exactly[/I] the same things.
If you are annoyed by this sort of petty ruling by the NFA, you have the option of taking your business off-shore — you can trade through a reputable British or Swiss broker, where hedging is allowed.
That’s what I have done. And I recommend it.
Clint, I’m seriously at risk of losing the considerable respect I have for you. I would love it if you could demonstrate for me how “hedging” in any way, shape, or form alters one’s performance over exiting and re-entering (the brokers, by the way, have admitted to their being no economic benefit to the trader).
[B]Sheesh, rhody, I hope THAT won’t happen!
I have no idea what I said to push your buttons — but, let me try to UN-push them.[/B]
I took jcgato’s post at face value. He asked, “What is hedging? How does it work?” I tried to answer his questions by giving him
the simplest, most understandable explanation I could give. If my explanation fell short, I apologize.
I did not try to editorialize on the pros and cons of hedging. And I did not intend for my reply to represent an endorsement of hedging as a strategy. Since you have apparently taken it that way, let me set the record straight.
I do not hedge my forex positions. I tried hedging once, a couple of years ago, and decided that I didn’t need that tool in my toolbox. But, that doesn’t prompt me to rail against hedging as some sort of sinister, evil thing.
As you have pointed out, a simple hedge accomplishes exactly the same thing as stepping out of a position, and then stepping back in (assuming that exit and entry points are the same in each case). The bottom line is the same for the trader.
And the bottom line is the same for the broker — one additional spread earned by the broker, either way. I think it’s ridiculous
to accuse brokers of some sort of abusive practice for allowing hedging — as if hedging were like account-churning.
[B]All that being the case, what difference does it make whether a trader (a) chooses to trade in and out of retracements,
or (b) chooses to hedge? To those who prefer hedging, I say ‘have at it’.[/B]
As for trading through a British or Swiss broker, my recommendation to do so goes beyond the topic of hedging. I have a very low opinion of the NFA, and their agenda to impose commodity-market rules and procedures on the forex market.
The turmoil created in the forex market over the past several months by the NFA represents some sort of power-grab, or ego-trip, on their part. Rather than cope with them, I simply chose to go elsewhere. I have written about this, here on the forum, many times, as I’m sure you are aware.
When the NFA issued their edict that henceforth stop- and limit-orders may not be tied to specific forex positions, I said,
“Screw you, NFA”, and I moved my accounts to London.
That move had nothing to do with the NFA’s ruling against hedging, which doesn’t affect me directly.
It does affect me indirectly, however, because it’s part of that power-grab, ego-trip, thing. It’s just one more manifestation
of the nanny-state mentality of U.S. financial regulators, and it annoys the hell out of me.
I’d be curious to hear why hedging is such a hot-button issue for you. I would think that nit-picky over-regulation by the NFA would be more worthy of your ire.
Clint
I’m going to go out on a limb and suggest that just about any of us who read “That’s what I have done. And I recommend it.” were inclined to take that as an endorsement. I’m glad to hear it isn’t. 
I tried hedging once, a couple of years ago, and decided that I didn’t need that tool in my toolbox. But, that doesn’t prompt me to rail against hedging as some sort of sinister, evil thing.
I’d say “evil” is a strong word. Swarmy is a good one, though, especially when the broker actually encourages it and offers up “hedging” strategies.
As you have pointed out, a simple hedge accomplishes exactly the same thing as stepping out of a position, and then stepping back in (assuming that exit and entry points are the same in each case). The bottom line is the same for the trader.
And the bottom line is the same for the broker — one additional spread earned by the broker, either way. I think it’s ridiculous
to accuse brokers of some sort of abusive practice for allowing hedging — as if hedging were like account-churning.[/QUOTE]
I’d like to hear your what you would see as non-simple hedges and the difference there.
That aside, I agree it’s the same, except where roll-over/carry is concerned for those holding overnight positions. This is where things get dodgy. The hedged position is at best going to be zero carry, but more likely will be negative carry because of the rate spreads. On top of that, the brokers hold margin against a position with zero exposure. What’s that about?
[B]All that being the case, what difference does it make whether a trader (a) chooses to trade in and out of retracements,
or (b) chooses to hedge? To those who prefer hedging, I say ‘have at it’.[/B]
My concern isn’t for those who want to trade around a position. It’s for those who hedge to avoid a margin call or as a stop. As dpaterso noted in another thread:
[I]In a ‘previous (trading) lifetime’ I used to use these ‘hedges’ to avoid margin calls (I’ve learned a little since then I’m sure) but ALWAYS the inevitable happened i.e. no sooner was one of the ‘hedged’ positions closed and price continued on its merry way until you were margin called ANYWAY!!! I also remember paying LOADS of interest on these ‘hedged’ positions (sometimes, most times, paying in BOTH directions).[/I]
Even more than that, it’s about those who think hedging makes their trading more profitable. I’ve had people tell me straight out that when they started hedging they became more profitable. As we have already established, hedging does not make your more profitable. It is the decision where to buy and sell that determines the bottom line. These people attributing their performance to hedging are actually stunting their own development, in my view, because they are not gaining the confidence in their own decision-making which is required for long-term success.
Also, there is much legitimate discourse here about thinking and acting like a professional. Part of doing that is understanding how pros view the markets and trading. No professional forex trader would ever refer to hedging as holding simultanous long and short positions. They think of it as what it is - no position.
Retail traders should not be encouraged to look at offsetting long and short trades as seperate positions, but instead as the singular exposure it is. It’s along the same lines as warning about how being long EUR/USD and long USD/JPY is basically a long EUR/JPY trade. Individuals need to be looking at the entirety off what they are doing.
When the NFA issued their edict that henceforth stop- and limit-orders may not be tied to specific forex positions, I said,
“Screw you, NFA”, and I moved my accounts to London.That move had nothing to do with the NFA’s ruling against hedging, which doesn’t affect me directly.
It does affect me indirectly, however, because it’s part of that power-grab, ego-trip, thing. It’s just one more manifestation
of the nanny-state mentality of U.S. financial regulators, and it annoys the hell out of me.
I totally agree about the nanny state, protect traders from themselves thing. I’m not a big fan of that. I do not, however, take any issue with accounting standardization, which is a large part of what they’ve done. That’s probably in large part because I started trading in stocks and futures where the accounting is FIFO (and that’s what the IRS requires for reporting as well, by the way).
[I]I just posted this over on another thread and started to read this one so I’ll repost in here too. [/I]
I’m not 100% about this but my understanding of the US aversion to hedging and the FIFO rules have more to do with IRS code regarding long-term cap gains tax vs short-term. Hedging and second positions (FIFO) could be used to maneuver a short-term profit into a long-term cap gain. ie: You’ve had a profitable long position for 8 months and is now starting into a down trend. If closed the profit would be taxed at the short-term rate. Holding a short hedge against the long for 4 months and one day would drop it to the long-term cap gains rate.
Opening a second long losing position against the first long position for the same 4 months and one day would then give you a short-term cap loss off setting part of the long-term cap gains from the long position.
So if I understand it correctly, it’s not about brokers charging double spreads as much as it is about taxes. In the US it’s always about taxes!
Thanks!
The practice of undertaking one investment activity in order to protect against loss in another, e.g. selling short to nullify a previous purchase, or buying long to offset a previous short sale. While hedges reduce potential losses, they also tend to reduce potential profits…
Be aware that not all brokers allowed it,mine ACM does because they are regulated in Switzerland, but NFA brokers don’t
My .02
So far there has been a lot of discussion in this thread concerning hedging and the pro’s and con’s of using it as a strategem etc. To be honest I haven’t read it all but let me say this…to be able to go both directions in the same currency at the same time is to me a super important requirement for trading and has driven me to europe.
To be able to go short and long when and/if I desire at anytime no matter what positions are open should be a fundamental right of a trader IMHO. To be told otherwise is extremely limiting especially if you trade different Time frames at the same time.
Hi, sandpipper
It’s been a while since I’ve seen a post from you. I hope all is well with you.
I agree with everything you said.
Although I don’t use hedging strategies, myself, I share your “libertarian” view that we should have the RIGHT to use whatever strategies our brokers choose to allow. [B]Get the busybody regulators out of our affairs.[/B]
Like you, I have moved my accounts overseas — the U.K. in my case — just to get away from the twits at the NFA.
I’m glad you’re back. Best regards,
Clint
Hey Clint,
Great to see you still over here dispensing sound wisdom. I’m in and out but mostly out just concentrating on trading and building my skills. One day I will have this down and then I feel like I will have something to share until then it is just an opinion with not much experience to back it up…so I keep plugging away.
When I do come over here though I look for your posts cause i enjoy reading what you have to say. I find we think similarly on a lot of things even though you are more well said.
regards.