Low-Risk Hedge (Arbitrage) Trading Methodology
Hello,
I've made some improvements to R1.0. Notes for changes are summarized in post #1. The new version R1.1.
Nice. Thanks for doing this. I will test this out this week.
Hello,
I've found a bug in the calculator, which arise due to careless mistake in derivation of lot size formula. The fix has been verified against broker's data. Should be correct now. Please find notes and attachment in post #1. The fixed version is R1.2.
Nice. Thanks for doing this. I will test this out this week.
You are most welcome! 
Please feel free to share your experience here.
Found another careless mistake... Fixed.
Please find new version R1.3 in post #1.
Is this for serious? So let me get this, you're buying and selling the exact same thing, paying the spread twice, and calling this profitable? It looks like math isn't a weakness of yours (assuming from the spreadsheet), but actually look at what you're doing. I opened the spreadsheet, and it told me to buy 1.06 lots and sell 0.71 lots of USDJPY. That means your carry trade is 0.35 lots, which (surprise!) gives the exact same pip value (risk), and MORE interest (don't take my word for it). And don't forget, you paid the spread twice.
If you want to do a USDJPY carry trade, do a carry trade. This is EXACTLY the same thing pip wise, and produces more interest and costs less.
Looks like you tried to combine the FR correlation carry trade with the impeccable hedge. The problem is that they are two very different things, and it seems like you don't fully understand how the impeccable hedge works. You need to find a currency triangle (or circle) that owns/sells the same currency amounts that is off-balance (one of the currency pairs overvalues or undervalues a currency when compared to others, comparing it back to itself).
Edit: And look up Arbitrage. I don't think you know what that means.
If you still think there's any validity in your approach, actually trade it (I hope you realize your mistake before that) compared to the difference in a carry trade. If you're confused why it doesn't work still, PM me.
Hello,
I've started a $50,000 demo account with the following settings:
Currency Pair: GBPJPY
Lot Size: 100000
Balance: 50000
Leverage Factor: 400
Margin: 30.0%
Bias: 60.0%
With the combination of 400:1 leverage and 30% margin, this an extreme condition would normally send partial hedge (FR/FFS) type strategies crashing...
Let's see how this hedge strategy works out.
I will be reporting the test status on a regular basis.
Is this for serious? So let me get this, you're buying and selling the exact same thing, paying the spread twice, and calling this profitable? It looks like math isn't a weakness of yours (assuming from the spreadsheet), but actually look at what you're doing. I opened the spreadsheet, and it told me to buy 1.06 lots and sell 0.71 lots of USDJPY. That means your carry trade is 0.35 lots, which (surprise!) gives the exact same pip value (risk), and MORE interest (don't take my word for it). And don't forget, you paid the spread twice.
If you want to do a USDJPY carry trade, do a carry trade. This is EXACTLY the same thing pip wise, and produces more interest and costs less.
Looks like you tried to combine the FR correlation carry trade with the impeccable hedge. The problem is that they are two very different things, and it seems like you don't fully understand how the impeccable hedge works. You need to find a currency triangle (or circle) that owns/sells the same currency amounts that is off-balance (one of the currency pairs overvalues or undervalues a currency when compared to others, comparing it back to itself).
Edit: And look up Arbitrage. I don't think you know what that means.
If you still think there's any validity in your approach, actually trade it (I hope you realize your mistake before that) compared to the difference in a carry trade. If you're confused why it doesn't work still, PM me.Hello,
the idea of this strategy is to earn interest on the long run. Its not a short term approach. With positive net interest coming in + the fact that the drawdown can be controlled to a big extent, the trade will be profitable on the long run.
I appreciate your thoughts on my work. Please feel free to share your opinions here.
Atonix,
I think you are right! Its a conceptual mistake on my part. I should have focused on the larger picture.
Thanks for pointing that out. Thats the benefit on sharing your thoughts on a forum. It shortens the learning cycle.
Atonix,
I think you are right! Its a conceptual mistake on my part. I should have focused on the larger picture.
Thanks for pointing that out. Thats the benefit on sharing your thoughts on a forum. It shortens the learning cycle.Yeah, it doesn't matter if this is a super-long term system. You're getting less than a simple carry trade, which is like randomly buying a currency, and hoping it goes up (while receiving interest).
I hope you didn't take my comments as harsh: I wanted to make sure you realized the mistake and didn't live trade this.
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Hello,
In view of the general level of interest and the number of inquiries I've received from many of the folks here, I've decided to start a thread to discuss on a low-risk hedge trade strategy which I've recently developed.
The idea behind this strategy is derived partly from the FR/FFS type partial hedge methods, which is extremely risky by nature, and partly from the impeccable hedge methods, which is virtually 100% safe, but is rather limited in earning potential.
With the FR/FFS type hedge strategy, a partial hedge is formed as a result of correlation between major currency pairs. For currency pairs that are strongly correlated, the differences in pip movements between each currency pair in hedge are usually small, but can fluctuate due to changes in the economic climate. For currency pairs that are less correlated, the differences in pip movement are larger. This give rise to a double-edge sword scenario, where the edge can be used for you, or against you - shredding you into pieces! For currency pairs that have stronger correlation, the effects are usually more mellow. However, this does not mean that you are on safe grounds, for there is NO GUARANTEE that the correlation between the currency pairs will stay forever.
Take for instance, GBPUSD vs USDCHF. These two currency pairs used very well correlated, fetching a negative correlation coefficient as high as -0.80. However, the recent changes in economic climate caused a huge drop in the correlation, leading to extremely large pip movement differences between the two pairs. Even EURUSD vs USDCHF, which has the tightest correlation among the major currency pairs along with EURJPY vs EURCHF, was quite seriously impacted as well. Will the tight correlation return once again? Maybe, but maybe not. But even if it return tomorrow, can anybody guarantee that it will not be lost once more? Nobody can predict for sure.
So, what can hedge traders do about this catastrophic scenario? What if they continue to operate the way they used to? Will their account will be wiped out one day, like the many whom got margin call between Jan to early this month? This is a very possible scenario... Murphy's Law states : "If things can happen, they WILL happen..."
Now, back to the strategy I'm going to introduce. While this strategy is based on the idea of hedging, it has been designed to avoid dependence on correlation between currency pairs, which is the single reason why FR/FFS type hedging methods fail. However, its also not a Buy/Sell same lot with same currency pair method. The reason why the latter method won't work is because the pip movement difference is zero. Coupled with the differences in interest rates between Buy/Sell same lot for same currency, which produces net negative interest, it will be a slow death process.
Between these two extremes, however, there is a ray of hope where one can generate sizable returns rather safely behind a solid hedge. So, how does the method work? First of all, the method is not dependent on hedging between separate currency pairs, which is often unreliable. It works by Buy / Sell with the same currency pair, however, in unequal lots. With this configuration, the pip movement difference is a zero-sum game, however, by buying and selling unequal lots, the pip cost for each trade is different. Hence, interest can be generated based on this difference, as the hedge pair is now structured in your favour. On top of that, opportunities for cash-grabs are expected, much akin to the positive side of FR/FFS type strategies, however, in a much less risky environment. Drawdowns are also expected, however, depending on how the lots are sized for each opposing trade, the risk can be minimal. This is mainly due to the fact that the hedge is operating on a zero-sum pip movement difference concept.
The currency pair chosen for this strategy is GBPJPY, not only because it fetches the highest interest rate per lot, but also because of the low differences (in term of %) between the Buy/Sell swap rates.
I have developed a calculator for structuring the trades. Please refer to the Excel spreadsheet attached, which contain instructions for using the calculator.
I have not tested the strategy thoroughly myself as it was a newly developed concept. I would appreciate any inputs from the esteemed members of this forum. In the near future, I am planning to develop an EA for this method.
Edit (March-24-2007) for R1.0:
I've included additional calculations for USDJPY. See attachment.
Edit (March-26-2007) for R1.1:
Fixed some minor calculation errors;
Re-defined the Bias so that it is now adjustable in terms of percentage;
Added calculation for Risk in terms of $/pip.
Edit (March-26-2007) for R1.2:
Fixed major error in lot size calculation. Careless mistake... Verified and checked against broker's data. Should be correct now.
Edit (March-26-2007) for R1.3:
Another careless mistake... *sigh*... Fixed.
Status:
Experiment closed. Reason: Conceptual mistake