More on Forex Strategy and Hedging

Now I have to have a really serious look at what I am trying to do with my trading.

It has been very frustrating recently having not made much progress, and having placed far too much faith in predictions I loaded up my USD side very hard, especially against the EUR given all the fundamental issues facing the eurozone, but of course the big correction came, and then the greek drama took centre stage making everyone hold awaiting that outcome and it has possibly restrained the kind of volatility I rely on as we have waited weeks for an outcome.

The euro is bound to come down, it’s just a matter of whether there will be a greek deal and it will bounce up first.

We now have to accept that many of the calls we made were very poor in that I did not manage those choices in a way that my system could withstand.

The first poor call was assuming a currency would not move more than 20% in a short period of a few months without some major global event. I did not see that the euro was already on a course hurtling down and by the time I got wise to it, I did make money and refine my methods but the sentiment had already begun to change.

The second poor call was going to far into dangerous hedges believing that I knew where the market was going to be based on every insistence from every source that the euro would dive to parity with the US. Now I have learnt, no one really knows how things will play, and hedging is all about short term protection at the cost of long term gain.

But we can’t forget we chose hedging as a way to save our system when the parameters became pushed which is what happened in each of those situations.

But I can’t help but feel I have more to learn about hedging, but now I also have a healthy distrust of my own confidence in trading now that I have seen how dangerous it can be.

I was actually pretty conservative on the kiwi. But again, just the kiwi pound has collapsed 19% in 2 months. I only had $5k on that trade, so in addition to the canadian, neither of which I hedged this has become an additional issue as now that the kiwi has tanked, it’s cost me $2k of my equity and the timing of that is all part of why I am so stretched.

It’s my legendary misfortune. I think I have bad luck because it’s a message from the universe that I am supposed to use my strategic ability rather than rely on luck, which I don’t have!

Unfortunately because my choices were so poor, I will have to enter into more hedging which will again push out my timetable for actually achieving some progress. But it will protect me and allow me to continue to make some cash.

I was aware of the danger that I was creating but my assurance was that if it ever got that bad I would simply hedge on the other side. Could it lead to massive balance hedges that could topple me with the smallest swnings as the both tug at my equity from both ends until there’s nothing left and I am pulled apart by two wild horses like some macabre torture?

However I have been thinking about what I should have done differently to protect myself and that is counter hedging immediately. Don’t wait until youre at breaking point on the other side.

This is where we can use a technical level. Don’t go into hedge mode until that resistance level is crossed, and buy in as it cranks up, sell as it winds down, especially as it touches the next technical level. If it pops the break, start again. Paying attention to technical levels will be another good way to make decisions when you’re riding a rally.

If I’d done this with the euro, basically waited for it to pop 1.06 and then start throwing in the hedges, and if I had kept it rolling I would have made thousands of dollars. But what if it turned around again?

You build it on the other side again, ready to roll out twice as large. The point being is before, you keep the numbers equal, no matter how high, and you choose your moment to start rolling off

As time goes on we are learning the patterns of the market, how break outs work, they’ll break and start pushing the ceiling, and then cool off, they may have a number of tries scratching at the ceiling in a day, each one lasting a few hours, and then they might chill out and try again tomorrow. Or next week.

You could have this $50k slab just sitting there at the end of the opposite side of your hedge. As your price action finally corrects you reduce it slowly from $50k. You could even do it in intervals to show the counting down process.

The idea of a $50k trade like this is that when it breaks out, you grab the tasty $50 profit, and replace it with a $20k, which you would then replace again with a $40k to make sure the trend was extending. again it would be the same on the other side. The $50k goes bad, drops $100 that is .2% then you put $20k in on the other side, if that breaks through, then you go with the $50k hedge on that side.

The assumption is that when you’re riding a hedge, it’s spiking up to new highs where it will eventually have to climb down and retrace at some point. When you’re fairly sure it has exhausted, you start building the hedge on the other side immediately. Yes the hedge may kick a new high after that and damn that will hurt, but you should already be past the big spurt and it may dwell up in this region for weeks and months, but another big spurt is probably within a 10% chance, and youre hedged up well anyway. Part of hedging as we first saw it was to then turn around and use the profits to pull out some dodgy looking positions that got left behind.

So what happens is the price point gets trapped tightly between two hedges.

You may have $150k on the long side but still a $50k hedge on the short side hanging at the edge of the high, when it breaks from the consistent swing up, thats when you roll a $10k and then a $20k hedge break, and once that breaks youre probably safe to top out at $50k. These will pull in decent profits.

But eventually it turns to go higher again, but here’s the deal. We got $200k rolling down on $50k, so once again, you turn in the $20k position. This is where stops to break even might be a good idea.

The key thing about hedging within tight ranges is that one side is making bigger profits than usual, even at a point where equit is being eaten as we lean to the far side.

Once the counter hedge kicks in, the other side is making equal losses, but those losses aren’t that unusual, it’s just a big tail when it’s the big head that’s causing all the problems, the grands worth of losses.

At some point it’s going to start coming down, and it’s at that point the big hedges coming in on the other side start being collected. Pretty soon youre 75k/225k. You will throw up the $20k on the $75k line, but that’s because you’re holding $200k all the way down to $100k on the other side, that’s when you start leaning toward the $125-$150k split.

Keeping the split number down is a sign of your judgement as every time the hedge goes the wrong way, it will rise on both sides.

Of course trends must be considered also, it is the euro and aussie tipped to sink long term while the dollar and pound will likely rise over time.

CASE STUDY

GBPAUD. We should have held $30k while grabbing $10k positions, the moment it turned around on the 90k, bang, counter with another $10k. What you eventually get is a big say $10k slab positioned as the gateway, perhaps at a point around $200 where it’s fallen to but gotten up again and again. As soon as we pull away, the $5k counter comes in. If it falls away, you take the pain knowing that the $5k’s coming down should give you some nice hits, and if it approaches again, squeeze it so if it pops either side , , ,

It has popped again and I have risked some counter hedge positions, but I’m not confident leaning over the edge, and have now wound down to $113 vs. 18k, that is a $95k difference – huge. This suggests huge confidence in me that this is topping out, but I will look for 40k vs 90k though with australian pairs we should always keep an extra $10k at least on the the australian side for carry.

Use carry to determine how much you carry.

EURUSD. When the USD starts dropping get some big wedges in behind it, but the moment it turns, drop the $5k hedge right there like we should have done from the top. Sure, collecting $5k hedges on the way down will hurt, but we will end ip rolling some big numbers on the US side.

Now I am more doubtful, considering that the euro could spend a year or more under $1.05.

But everyone seems to have a theory – so many big names are insisting on parity at some point. But then so many people keep saying that this is what the big players want us to believe, the euro has seen it’s massive decline, it is now the US faltering, and we’ll see the euro rise up where it belongs, and after that who knows, if the US data can’t recover we may have already seen the bottom.

***

So please tell me again, the story of how all this works out?

Well whether it takes weeks, months or happens tomorrow, the USD will rise again, pushing me well over $15k and towards $20k, at which point I will be adding to my lots to over $3k margin, but always weary of where I am keeping my hedges, I want the hedges to balance at halfway.

If it stops after 1.05, we may look to settle the hedge around $200k, but going to parity, that may be $250 on both sides, while after parity, we begin winding the hedge down.

My assumption is we would be well into at least $18k by then, hopefully 20k, though going to 20k equity is going to surely encourage a bit of adventure

The facts are that I may not be able to lift my earnings significantly without really hedging in, and so that’s why the $20k level is so important, because it’s at that point we get to be more daring.

But it also may leave me asking serious questions about which way these currencies are heading and therefore, we have to go back to our own fundamentals.

You hold a hedge to keep the balance so you’re alway safe no matter what happens. How we space out the money we throw down depends on the technical ranges and the price movements, congestion forces you to throw money down, by break outs allow for clean outs.

It’s only when you get to the edge, the last quartile, that you begin to wind down the hedge so when it finally tops and reverses, you’re holding little more than 10% on that side. Whether you have to hedge and how much always depends on how badly things are going. New highs will become harder to come by, and that’s where we’ll claw it back.

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