Anyone use direct (indirect if you're good enough) hedges instead of stops?

Been toying with the idea for a while.
Any good or recipe for disaster? What say you?
Would be nice to hear of your experiences too.

i've thought about it..but when do you exit the hedge? if you keep exiting and re-entering it you'll end of churning away profits by the spread...so a protective option is the best hedge imo

I'm thinking about it more in terms of timing rather than getting the trade wrong. If it gets to a certain level away from the entry where I think the trade will never pan out I'll could just cut it or manage it and attempt to profit from any pull-backs or intra-day noise/ranges etc.
I cant afford options so I'm thinking of the extra spread as comparable to paying option premium lol. Plus I don't know how to calculate and manage the greeks so a delta 1 hedge is nice, simple and easy to understand.

By direct hedge I assume you mean taking an equally opposing position to the one you currently hold, for example, being long 1 unit of XYZ and going short 1 unit of XYZ. Assuming you can even hold two offsetting positions like that (only in forex can you actually do it in the same account, but only outside the US if your broker permits it), there is no financial benefit to doing so. In fact, as you've noted, there is often a cost in terms of spreads, carry/roll, etc., not to mention having your margin tied up. Whether you open and offsetting position or close out your existing one, the P&L is always going to end up being the same because you're doing precisely the same transactions.

You cannot compare this sort of "hedging" to an option. With a "hedge" the moment you put it on you freeze everything - you can neither make nor lose any money so long as both legs remain on. With an option, that's not the case. When you buy a put to hedge a long it basically caps your downside, but if the market goes your way it doesn't offset that move other than in what you paid for the put.

"Hedging" is basically the "I don't want to take a loss" strategy. But the fact of the matter is, as long as you've got the hedge on you've locked in the loss.

Yes I see that rhody trader but aside from margin being tied up and assuming that isn't an issue, what is the difference between locking in a loss and taking losses through stop-loss?
The loss is all but certain but with a direct hedge you have the possibility of cutting at different times and maybe coming out at a profit.
I'm just thinking about beginners like me who are really poor at timing. I can lock in a loss and let it run instead of trying to get in multiple times and suffering multiple losses.

scose

In my main account (uk ftse100 equities) I will often hedge with ftse100 as price nears a danger point for the move - overhead potential resistance for example - rather than tighten stop. I hold the hedge until the mist clears. Sometimes this costs a bit - eg: long share and short hedge where the market roars upward whilst the share splutters around its resistance level before following suit - but is a bit like an insurance premium to keep you in a move. Sometimes the hedge brings you in a bit extra - eg: market collapses whilst share is much more reluctant to fall.

In my play account I spreadbet ftse and you might be interested in the following couple of posts if you didn't see them:

http://www.trade2win.com/boards/uk-indices/83286-swingin-ftse-2010-a-45.html#post1184514
http://www.trade2win.com/boards/uk-indices/83286-swingin-ftse-2010-a-46.html#post1185384

jon

The only way you could hope to have this work is if your hedge goes into profit and you are able to get your hedge to the point where you can put a break even stop in. Until that point you have locked in a loss and it's the same as stopping out.
If you want to trade like that, it's better that you look at running bet pairs or running your account as a portfolio where you have some long exposure some short exposure, etc.

Hmmm never though of doing that. Thanks Barjon good posts.

I do it all the time.

SanMiguel said:

The only way you could hope to have this work is if your hedge goes into profit and you are able to get your hedge to the point where you can put a break even stop in. Until that point you have locked in a loss and it's the same as stopping out.

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Unless as I said earlier you miss your original by bad timing then you close out the hedge for a profit and the trade starts to move your way.
That way you make hedge profit - spread - loss on original position/+profit on original position.

I was only thinking of applying this to trying to catch swings really.

im reading natenburg.

options are hard

Chartsy said:

im reading natenburg.

options are hard

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understatement lol.

I had to give up on them for the time being. I'm already biting off more than I can chew as it is. I was overloading.

Good luck with it.

Martinghoul said:

I do it all the time.

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To me it seems far better than just blindly accepting loss after loss for the sake of missing an entry by x pips. Especially when you consider the size of intra-day ranges and whatever number of things that could knock you temporarily offside. Especially if all it means is you tie up some margin.

How do you do your hedging? I mean do you do quant stuff? You trade stirs right?

scose-no-doubt said:

Yes I see that rhody trader but aside from margin being tied up and assuming that isn't an issue, what is the difference between locking in a loss and taking losses through stop-loss?

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There is absolutely no difference, as I noted previously, except potentially additional transaction costs.

The loss is all but certain but with a direct hedge you have the possibility of cutting at different times and maybe coming out at a profit.

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Say you get long at 100, and the market falls to 90. Your options are to hedge or exit. Either way you sell at 90. Either way, if you want to make that 10 points back you have to buy again (assuming a play on rising prices). Either way, you have to figure out where to make that purchase. It all works out the same with the P&L.[/QUOTE]

I'm just thinking about beginners like me who are really poor at timing. I can lock in a loss and let it run instead of trying to get in multiple times and suffering multiple losses.

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The problem I have with the hedge vs. non-hedge approach - putting aside additional potential costs - is that it muddles your performance metrics and it can lead to very illusory P&Ls. For example, if you're looking at a closed trade P&L plot (which most folks tend to do because it's simpler) the hedged trade above would show no change for a long as you had that hedge on, and maybe longer depending on what ins and outs you did around it trying to make that 10 points back, and wouldn't reflect all those additional trades. If you closed the trade it would show a 10 point loss right away, which is more reflective of the reality of your performance, and would also show the performance of the follow-up trades.

There's also the hocus pocus it does with win rates (which get way too much attention). The hedging thing gives people a chance to claim a much higher win rate than is reality because if they are able to scramble back the loss on the initial position they can say it wasn't a loser, even if it took 10 more trades to bring it back.

scose-no-doubt said:

To me it seems far better than just blindly accepting loss after loss for the sake of missing an entry by x pips.

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To my mind, taking loss after loss is a pretty fair indication that you've got a problem in your strategy somewhere.

scose-no-doubt said:

To me it seems far better than just blindly accepting loss after loss for the sake of missing an entry by x pips. Especially when you consider the size of intra-day ranges and whatever number of things that could knock you temporarily offside. Especially if all it means is you tie up some margin.

How do you do your hedging? I mean do you do quant stuff? You trade stirs right?

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I trade all sorts of rates products, e.g. STIRs, bonds, whatever...

The way I look at it is simple. Every trade, apart from its own merits, has some exposure to the main factors I care about (for example, it is either a long or a short in the current regime). Every time I put a trade on, it either adds overall factor exposure to my book or hedges that exposure. So the art is then, simply, picking your trades, such that you're comfortable with the factor exposure your whole portfolio has. So, in the context of the question, every trade is potentially a hedge.

Martinghoul said:

I trade all sorts of rates products, e.g. STIRs, bonds, whatever...

The way I look at it is simple. Every trade, apart from its own merits, has some exposure to the main factors I care about (for example, it is either a long or a short in the current regime). Every time I put a trade on, it either adds overall factor exposure to my book or hedges that exposure. So the art is then, simply, picking your trades, such that you're comfortable with the factor exposure your whole portfolio has. So, in the context of the question, every trade is potentially a hedge.

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I would hazard a guess but for the most part people do not trade portfolios here, they trade 1 or 2 instruments at a time or specialise in 1 instrument say the FTSE - I think that's an issue but don't forget that the stop is there to tell you you are wrong, it should be in a safe enough place that it can't be hit unless you are completely on the wrong side of the move.

There are exceptions. When the market was drifting up on low volume at the start of the year I was short and getting into worrisome territory with the move - that would be a time to open up a hedge as it was very clear to me that we were going down, I just didn't know when - it took 2 months for that to happen but that was with a 10% stop loss on the SNP a very small trade size for a swing trade.

Intraday, I just don't know if it's worth it, you can't be set on a particular direction for just 20pts of a move because anything could affect it.

If you want to trade bet pairs then that's a different strat entirely.

Well, if you trade one instrument and have a view only on that instrument, the only hedge is a stop. As soon as you add more trades, no matter if it's one or several, you have a portfolio and everything I said applies. To me, it's clear that hedges are meaningful only in a portfolio context, almost by definition.

Some of you guys seem to be having difficulty with what is or isn't a hedge, so I made a little poster for you to look at any time you think about hedging in MT4 or whatever.

(sorry but it was only a matter of time before someone made the joke. At least I tried to be original)

I just did a sex wee