"Hedging" in Forex trading -Why do it?

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Keith Watford
Moderator
18450
Keith Watford  

if I may offer my opinion.....

Hedging is a method to limit risk.

Consider this scenario.....

You may consider an investment in ABC Oil to be a good as you feel that it will outperform the market.

However you know that the whole oil sector can be volatile, so if the sector falls, ABC Oil will fall with it, even though it is a solid company.

So what you do is you Buy ABC Oil and at the same time you short the oil sector.

This limits your risk as if the oil sector falls, your short will gain and as long as ABC Oil outperforms the other oil companies, you will have a net profit.

This is hedging.


There is no such thing as true hedging in Forex.

True hedging is not opening an opposite trade in the same instrument, yet that is exactly what so many traders do.

There is no logic behind this at all, so I do not understand why it is so common.

Say you have 1 lot Buy open with EURUSD and it goes 100 pips in loss.

So you "hedge" it with an opposite 1 lot Sell.

You are now in a position where if the EURUSD falls another 50 pips, the Buy order now shows a loss of 150 pips and the Sell a gain of 50 pips. A net loss of 100 pips. EXACTLY  the same as if you had simply closed the Buy order. No matter whether the price goes up or down, the net position will always be a net loss of 100 pips.

Also, should the trades be held overnight, swap charges will be applied (maybe triple swaps), so now the loss is bigger than it would have been if the Buy trade had simply been closed.

Not all brokers offset opposite orders in the same instrument against margin requirements, so there is a risk that there may not be enough free margin to open the "hedge". In an EA, this could leave you exposed to more risk than you are comfortable with.

If there is not the intention to "re-enter" the Buy by closing the "hedge", then you also incur additional spread/commission charges.

So it is not just my opinion that "hedging" in Forex is unproductive and pointless, it is a fact. When swaps are taken into account, "hedging" actually loses more money.

My advise to anyone when considering "hedging" in Forex is "Don't do it". You are not hedging, you are opening an opposite order in the same instrument.


Now there will be some who will say "Ah yes, but what if instead of Selling 1 lot as the hedge, I Sell 1.1 lots?"

Again, don't do it, there has to be a reason to Sell. If you have a reason, then close the Buy and open a 0.1 lot Sell. It has the same result, but without additional charges.

Fernando Carreiro
4945
Fernando Carreiro  
Keith Watford: if I may offer my opinion ... Hedging is a method to limit risk ... There is no such thing as true hedging in Forex ... Again, don't do it, there has to be a reason to Sell. If you have a reason, then close the Buy and open a 0.1 lot Sell. It has the same result, but without additional charges.

Hear, hear!

I will however take it a step further -  It is not an opinion, it is FACT! Most traders however cannot seem to get their heads around it and continue to dispute it, just like the "Gridders" and the "Martingalers"!

Alain Verleyen
39033
Alain Verleyen  
Keith Watford:

if I may offer my opinion.....

Hedging is a method to limit risk.

...

There is also "hidden risk", I learned it the hard way 5 years ago when I started trading. I had trade(s) in the wrong direction and started to panic, so I said me I will open an "hedge" to win some times, to calm down and have time to decide something, so I did. The margin level was very close to stop out (around 120%) but I was saying me "I am safe". Hovewer the total lot size was very big (don't remember exactly), and what happened ? ... the account has exploded (all trades closed by stop out, margin level below 100%), without me changing anything, but there was a spike (probably a news I don't remember).

I could not believe it, started to think the broker cheats me (as everyone ). I checked all...10 times...to finally understand there was no cheating but just me being stupid. Before explaining what was the reason, it could be fun the ask if someone can explain why the account was blew out while my trades was fully "hedged" ?

Amir Yacoby
1367
Amir Yacoby  
Alain Verleyen:

There is also "hidden risk", I learned it the hard way 5 years ago when I started trading. I had trade(s) in the wrong direction and started to panic, so I said me I will open an "hedge" to win some times, to calm down and have time to decide something, so I did. The margin level was very close to stop out (around 120%) but I was saying me "I am safe". Hovewer the total lot size was very big (don't remember exactly), and what happened ? ... the account has exploded (all trades closed by stop out, margin level below 100%), without me changing anything, but there was a spike (probably a news I don't remember).

I could not believe it, started to think the broker cheats me (as everyone ). I checked all...10 times...to finally understand there was no cheating but just me being stupid. Before explaining what was the reason, it could be fun the ask if someone can explain why the account was blew out while my trades was fully "hedged" ?

Spreads got very wide?
Amir Yacoby
1367
Amir Yacoby  
Keith Watford:
 

Say you have 1 lot Buy open with EURUSD and it goes 100 pips in loss.

So you "hedge" it with an opposite 1 lot Sell.

You are now in a position where if the EURUSD falls another 50 pips, the Buy order now shows a loss of 150 pips and the Sell a gain of 50 pips. A net loss of 100 pips. EXACTLY  the same as if you had simply closed the Buy order. No matter whether the price goes up or down, the net position will always be a net loss of 100 pips.


This is useless, but it is not how it's supposed to be used.

Let's take another scenario:

You have 2 strategies, both of them work on same symbol but different timeframes.
Both use different risk/reward and so different volumes traded.

One is a swing trade on the daily or something, and it goes long (one or more orders depending on the strategy).
The other scalps short, or maybe another strategy already trades the monthly short.

The scalp short position uses say 1 lot but stop loss of 30 pips and the daily swing long has stop loss of 200 pips but position is 0.1 lot.

So, to simplify the management of different strategies it is useful to use hedging, but of course not the way you described.
Of course you could achieve it without hedging but it will be much more complicate to manage.

Keith Watford
Moderator
18450
Keith Watford  
Amir Yacoby:

This is useless, but it is not how it's supposed to be used.

Let's take another scenario:

You have 2 strategies, both of them work on same symbol but different timeframes.
Both use different risk/reward and so different volumes traded.

One is a swing trade on the daily or something, and it goes long (one or more orders depending on the strategy).
The other scalps short, or maybe another strategy already trades the monthly short.

The scalp short position uses say 1 lot but stop loss of 30 pips and the daily swing long has stop loss of 200 pips but position is 0.1 lot.

So, to simplify the management of different strategies it is useful to use hedging, but of course not the way you described.
Of course you could achieve it without hedging but it will be much more complicate to manage.

What you are describing is not considered "hedging". You are describing using 2 different strategies that may happen to open opposite orders to each other. You are not using the opposite trades to "hedge " as the opposite trades are completely independent of each other.
Amir Yacoby
1367
Amir Yacoby  
Keith Watford:
What you are describing is not considered "hedging". You are describing using 2 different strategies that may happen to open opposite orders to each other. You are not using the opposite trades to "hedge " as the opposite trades are completely independent of each other.
It is hedging in the meaning of openning orders in differnet directions.

It is not hedging as interpreted in your post to limit your risk by openning the same order on other direction, this we all agree is useless.
Keith Watford
Moderator
18450
Keith Watford  
Amir Yacoby:
It is hedging in the meaning of openning orders in differnet directions.

It is not hedging as interpreted in your post to limit your risk by openning the same order on other direction, this we all agree is useless.

It is not "hedging" as the trades depend on different strategies.

If I buy EURUSD according to my strategy and you sell EURUSD according to your strategy, we are not hedging each other. We are working with a totally separate algorithm.

honest_knave
Moderator
2308
honest_knave  

Personally, I don't hedge.

I am aware of certain strategies that employ hedging to mitigate losses.

Example:

  • Long on a Buy signal but price drops.
  • Now a Sell signal.
  • Short on the signal, but rather than close the long it is held open and more lots added to the short.
  • Once the loss on the long order is sufficiently mitigated by the extra lots on the short, they are both closed leaving only a standard-sized short.

I presume it gets rather ugly if the sell trade falters and price rises. Now what do you do? Hedge the hedge?

I guess it comes down to the probabilities of the system in question, to which I can't comment.

I'm not saying I agree with this methodology, but there is a school of thought working that way.

Amir Yacoby
1367
Amir Yacoby  
Keith Watford:

It is not "hedging" as the trades depend on different strategies.

If I buy EURUSD according to my strategy and you sell EURUSD according to your strategy, we are not hedging each other. We are working with a totally separate algorithm.

Well, again, your interpretation to hedging is BUY 1 LOT and SELL 1 LOT - this we agree is useless.

My interpretation is whenever you have 2 opposite orders, it can be viewed as hedging (this is what MQL5 does not allow, even on different strategies as I suggested).

And, like MQL5 - you could still work on 2 strategies without hedging, with net positions (when you have 0.1 LOT long and you want 1 LOT short, you can close the 0.1 and open 0.9 short) -
but it would make the managing less straight forward.

Me and you now talk semanthics, so I suggest we leave it at that as we both agree about the meaning.
honest_knave
Moderator
2308
honest_knave  
Amir Yacoby:
Well, again, your interpretation to hedging is BUY 1 LOT and SELL 1 LOT - this we agree is useless.

My interpretation is whenever you have 2 opposite orders, it can be viewed as hedging (this is what MQL5 does not allow, even on different strategies as I suggested).

And, like MQL5 - you could still work on 2 strategies without hedging, with net positions (when you have 0.1 LOT long and you want 1 LOT short, you can close the 0.1 and open 0.9 short) -
but it would make the managing less straight forward.

Me and you now talk semanthics, so I suggest we leave it at that as we both agree about the meaning.

https://www.metatrader5.com/en/news/715 

 

 

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