Hedging (My Approach):
The reasons for writing about HEDGING this week is because several of you wrote to me asking me questions on how and why I HEDGE on my FUNDAMENTAL trades? I only ever use this approach on long-term position style (FUNDAMENTAL) trades. For me, it is just something that I introduce on a losing pip value related to my risk tolerance for a trade.
I hope that the example below is easy to follow:
TRADE 1:
EUR/AUD LONG
ENTRY: 1.5000
POSITION SIZE: 5 x MICRO LOTS MONTHLY ATR: 720
STOP LOSS: 1.4250
TRADE RISK IN TOTAL = $375.00
HEDGED LOSS MAXIMUM 200 pips = $100.00
Therefore in this instance, I would place an order with my broker at the same time as the initial trade to sell the EUR/AUD as follows:
HEDGED TRADE:
EUR/AUD SHORT
ENTRY: 1.4800
POSITION SIZE: 5 x MICROLOTS
STOP LOSS: 1.5000
By doing this, I am allowing “wiggle room” of 200 pips for the pair when the first trade is activated to move in the direction that I want it to. If the pair drops more than 200 pips my HEDGE is triggered, so my trade is always limited to a loss of 200 pips and a financial loss of $100.00.
You must also consider with the exotic cross-rate to currencies the overnight swap rates mount up very quickly and this can become quite expensive. This was the reason I closed my 6 trades last week that were hedged. My losses were limited, but the overnight costs were mounting on 12 trades. It is my approach, as I promised I would detail my way of approaching hedging.
Below I have supplied you with HEDGING definitions and styles that I was taught as a “Newbie” trader.
Using a Hedging Strategy in Forex:
Hedging is a way to protect you as a Forex trader against a big loss. The best way to view hedging is to consider it insurance on your trade. I view it as a way to reduce the amount of the loss that you would have incurred if something totally unexpected happened.
Some brokers will allow you to place trades that are direct hedges. This means that you are allowed to place a trade that has you both buying and selling the same currency pair at the same time if you want to do that. While the net profit is zero when both trades are open, you can make money without additional risk if you time the market right.
Simple Forex Hedging:
The simple hedge allows you to trade in both directions with the same currency pair without having to close the initial trade. It can, of course, be argued that it makes sense to close the initial trade for a loss (if it was a losing trade) and enter a new trade at a better price, still keeping the hedging trade active. This is up to you as a trader. You could definitely close the original loss-making trade and enter again in your original direction, but the benefits of the hedge are that you can keep your trade on the market and make money on the second trade that makes a profit as the market moves against your initial trade. When you suspect that the market is going to reverse and your initial trade will be heading for a positive position, you can set a stop on the hedging trade, or you could of course just close it.
Complex Hedging:
Some brokers will not allow you to hedge directly in the same trading account with the same currency pair so that an alternative method could be adopted.
As you know, there are currency pairs that have inverted relationships so if you go long or short on one you can go in the opposite direction with the other pair. While this isn’t a perfect science, it is in effect HEDGING.
EUR/USD and USD/CHF EUR/GBP and GBP/CHF
The above pairs tend to operate in an inverted manner, and this could be described as hedging.
Reasons to Hedge:
The main reason that anyone trading any security or forex pairs wants to use hedging is to limit risk.
HEDGING can be a bigger part of your trading plan if done carefully. Only experienced traders that understand the market swings and timings should see HEDGING. It is NOT something that without adequate trading experience should be played with, as it can be costly.
The Hedging Strategy:
With my example, at the beginning of this section, you can see that the whole basis of my hedge was firmly positioned around risk.
They are Four Parts to the Strategy that MUST be adhered to:
1. Analyze Your Risk
As any normal trade – assess your risk before you enter.
2. Determine Your Risk Tolerance
Are you hedging the full or partial amount of the trade? This is based upon your risk tolerances and your TRADING PLAN.
3. Determine Your Forex Hedging Strategy
Write it out to check, prices, levels, and entry and exit rules.
4. Implement And Monitor Your Strategy
Check your figures and entries and exits should the HEDGED TRADE trigger.
Comments
Post a Comment