Hedging, what it means?
- Thread starter waelmg
- Start date
I asked a market maker once whether they allow this, a position long and short at the same time. They said no, as "this would effectively give you no position at all."
I said, "well, for hedging purposes."
They said "but-but-we dont allow it , so you cant and its silly" and promptly changed the topic.
Ok, thats not what they actually said, but close enough.
Partial hedging, full hedging-the real objective of either isnt to lock in profits, by definition your giving some away, but to (try) and prevent total catastrophy on a trade damaging your capital.
I said, "well, for hedging purposes."
They said "but-but-we dont allow it , so you cant and its silly" and promptly changed the topic.
Ok, thats not what they actually said, but close enough.
Partial hedging, full hedging-the real objective of either isnt to lock in profits, by definition your giving some away, but to (try) and prevent total catastrophy on a trade damaging your capital.
this can be used IF you know what you're doing. IE, if you're in a longer term trade but want to scalp / day trade in the opposite direction, then the idea of "hedging" comes in if the dealer allows no extra margin for being net neutral on a position. so basically if you can do this, then you benefit by no extra margin requirements. otherwise, hedging has zero use other than another spread payment as someone mentioned above.
that's ridiclous. you don't hedge by holding position in opposite direction of the same asset.
hedging is about hedging the risks involoved in holding the underlying asset, and if u hold the same asset in opposite direction, you don't even have a position.
a general hedge is hedge against the market so that you cut away the market risk involoved in ur trading, i.e. go long on the instrument u are trading and go short on S&P500 or Nasdaq100 (as if they are the 'market' and if they change greatly it can pose a risk to ur trading - of course this depends on the correlations).
anothe example is hedging credit risk, so you buy bonds and at the same time u enter credit default swap contract that protect u against the bond defaulting.
other examples you go long on a stock, at same time buying put options to hedge ur bet. or u want to sell call options and u hedge by buying the underling asset.
one good way of hedging is pairs-trading, finding two very similar companies in the same industry, going long in the dominant one, and shorting the 2nd one.. if market news is good, ull gain more, and if its bad, u should gain more again (again if u're pickings are right). this is called market neutral or stat-arbitrage strategy.
sometimes investing in other countries exposes u to FX risk, so you might need to hedge against $ or the local currency against the underlying asset (again this depends on correlation between the two).
in short, heding is about getting rid of the risks involoved in ur trading as much as u can. holding positions in the same way in opposite direction is not heding. u're basically closing ur position.
JUST TO ADD: as much as hedging is a great way to minimize ur risk - it will also minimize returns, and some major traders don't hedge at all for this reason - but it some have blown up pretty quickly. it really depends on ur approach and how important hedging is to you. some hedge funds are very succesfuly heding all their positions.. hope that helps.
The use of hedge can be
(1) For protection of your capital. I heard some traders don't use stop loss, instead they hedge their losing positions. I personally don't like the idea. It's best to cut your loses quickly and move on rather than hedge and pay extra spread for a losing position.
(2) To take advantage of short term corrections (not a true definition of hedge). For example, you're holding long AUDJPY as a long term trade, then as you're anticipating a correction you do short term short while holding you long positions. If it is done correctly, one may save from paying for more spread than simply reversing trades from long to short to long and etc.
Some FX brokers allow you to do a full-hedge by longing and shorting a same pair simultaneously. One can also do a partial-hedge by longing and shorting correlated pairs (e.g. Long EURUSD and short GBPUSD at the same time).
(1) For protection of your capital. I heard some traders don't use stop loss, instead they hedge their losing positions. I personally don't like the idea. It's best to cut your loses quickly and move on rather than hedge and pay extra spread for a losing position.
(2) To take advantage of short term corrections (not a true definition of hedge). For example, you're holding long AUDJPY as a long term trade, then as you're anticipating a correction you do short term short while holding you long positions. If it is done correctly, one may save from paying for more spread than simply reversing trades from long to short to long and etc.
Some FX brokers allow you to do a full-hedge by longing and shorting a same pair simultaneously. One can also do a partial-hedge by longing and shorting correlated pairs (e.g. Long EURUSD and short GBPUSD at the same time).
As was said, going long and short the same pair is completely stupid. You have a net zero position, end of story.
Going long one pair and short another that is correlated is, as was also said, going long the combo pair (ie, in the EUR/GBP example above).
Batman had the best commentary regarding hedging. If you want to hedge...say...a USD/CAD long position, then go long oil to hedge. Since the CAD follows Oil pretty well, it goes to figure that as oil goes down, you are protected somewhat by your USD/CAD position.
Are you long oil? Then perhaps you should look at going short CAD/JPY. That kind of thing.
Going long one pair and short another that is correlated is, as was also said, going long the combo pair (ie, in the EUR/GBP example above).
Batman had the best commentary regarding hedging. If you want to hedge...say...a USD/CAD long position, then go long oil to hedge. Since the CAD follows Oil pretty well, it goes to figure that as oil goes down, you are protected somewhat by your USD/CAD position.
Are you long oil? Then perhaps you should look at going short CAD/JPY. That kind of thing.
You're right, long EUR/USD and short GBP/USD would essentially give you a long with EUR/GBP. That's why I called it a "partial-hedge" (maybe that's a misleading term). The reason I said that is because EUR/USD and GBP/USD are generally correlated to each other by a factor approximately between 0.65 and 0.95 for the past two years. So having known that, one can size the positions of the two pairs to do a "partial hedge".