So what is Hedging exactly?

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OddTrader

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So what is hedging exactly?

No silly gardening jokes please. Hedging involves locking in a price to buy or sell a commodity in the future. It is a form of insurance against adverse moves in markets notorious for them. Hedging is also employed in currencies, interest rates and stock indices, but it originated in grain markets.

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Hedges can be costly. Mexico paid banks $773m for options to hedge its 2015 oil exports at a sale price of $76.40 per barrel. (The deal already appears worthwhile, since Mexico’s oil now fetches less than $50 on the spot market.)

Companies using futures can face hefty margin calls — or demands for more collateral — if the market moves against them. Margin calls prompted by a cotton price increase bankrupted some merchants in 2008.
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Hedging can be costly and risky, unexpectedly and beyond timely comprehension!?

http://bigthink.com/econ201/when-is-hedging-more-like-speculation



When is Hedging More Like Speculation?

by Daniel Altman

almost 4 years ago

What's the big deal about J.P. Morgan's $2 billion trading loss? Austan Goolsbee, an economic advisor to President Obama, said the American public should be concerned because, in his words, it owned a life insurance policy on a guy who just got into a motorcycle accident without a helmet. But I think that may be an exaggeration. The bigger question is whether it makes sense for "portfolio hedging" to be part of a bank's business.

A trader in J.P. Morgan's London office managed to lose about $2 billion by trading in the derivatives markets. The bank was aware of the loss and stopped trading by the manager who was responsible last month. He had lost an enormous sum, but it still amounted to less than one percent of the bank's net worth. J. P. Morgan's stock dropped by about 9 percent on Friday, and other big banks suffered smaller drops.

Did this kind of trading put J.P. Morgan's viability at risk, as Goolsbee implied? Probably not - even if the loss had gotten ten times as large before the bank stopped the trading, it wouldn't have gone under. Did it put the financial system at risk? Hardly - in this case, the bank's internal checks seem to have worked. And indeed, in past years J.P. Morgan made billions from "portfolio hedging" - the label it gave to this kind of trading. Making big losses from time to time was to be expected.

But that's where the odd part of portfolio hedging comes in. In theory, these trades are meant to balance risks on the bank's own balance sheet, protecting it from any big losses. There are lots of ways to do this; the simplest is to buy an asset whose prices goes up when the asset being balanced loses value. If this was all J.P. Morgan did, then a winning year in the portfolio hedging unit would mean a losing year somewhere else, and vice versa; in this case, the $2 billion loss would be offset by gains on another part of the bank's balance sheet - perhaps even a cause for celebration, rather than hand-wringing.

Yet this kind of hedging is not all J.P. Morgan's portfolio hedging unit does. In truth, the unit is essentially a huge hedge fund - a term that itself has often come to mean "speculating" as much as "hedging." Its goal, like every other trading desk at J.P. Morgan, is to make money.

So does the portfolio hedging unit do anything to balance the bank's risks, or is it just a risk in itself? Well, it is possible to hedge and make money with the same portfolio. Let's say that you have two assets. One of them goes up in value when A happens. The other goes up when B happens. They both go up when C happens. So each asset is a hedge for the other, but they could both gain value. But if they both lose value when D happens, then together they might make your portfolio more risky, too. The problem at J.P. Morgan was of the D variety.

When the portfolio hedging unit is successful, it builds J.P. Morgan's asset base and balances its risks. Both of these outcomes should increase J.P. Morgan's ability to lend to and invest in growing companies. The question is how much of the latter outcome is really happening. If the answer is "a lot", then portfolio hedging is helping the economy to expand. If the answer is "not much", then there's no reason for this hedge-fund-in-all-but-name to be part of J.P. Morgan; the risk of a costly implosion may be a lot smaller than Goolsbee suggests, but it's still not zero.

Right now, we don't know the answer, and neither do regulators. They don't know enough about J.P. Morgan's trading, and they haven't even devised a way to ask the question. Perhaps they should.
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I don't see opportunities for hedging on forex. You can just worsen your position and drive your account to deeper loses, IMO. Better to use tight SL's to protect you from volatility.
 
doggyfx said:
I don't see opportunities for hedging on forex. You can just worsen your position and drive your account to deeper loses, IMO. Better to use tight SL's to protect you from volatility.
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Or better yet read the article the OP posted, which is about natural hedgers not a trading strategy!
 
Hedging is like the car insurance and you have four teenagers using the car.

Hedging is like a farmer growing corn and uses the futures markets to sell at top prices before harvest.

Hedging is like a trader who got beaten up like opponents of Mile Tyson, discovered the "trend is not your friend" in the beginning, but knows reversal is due.

Hedging is a way to insure you won't go belly up when you believe in the stats of your Trading Plan is right.

You spend long enough time studying, thinking, back testing, and KAZAAM, you figure it out, how to do it without ruining you. There is risk in everything we do, but what most people don't study and read is risk management. And there are no simple books on risk management, although I have not bought a book in past five years on financial markets that I can remember.

It is just like retail day trading, you have to do 100% return in a year to breakeven on fees. If you don't plan on breakeven plus one tick, most newbies will be having losing year and account. That making one tick to pay for fees can be considered a hedge of being wiped out.
 
Q: What is hedging?
A: Hedging is insuring against potential loss.


Most hedging is voluntarily but some are compulsory such as auto insurance. Credit Spreads and Debit Spreads are a form of hedging.


:)
 
I use hedging when position trading and my position is in profit, but hasn't quite reached a target and it looks like price could bounce and potentially reverse.
 
I Know You said:
I use hedging when position trading and my position is in profit, but hasn't quite reached a target and it looks like price could bounce and potentially reverse.
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Yeah but don't you lock in profits too?
 
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