Recently, on my FXCM live account I have been experimenting with hedging. After studying this a while, it occured to me that this may actually be a better approach than a traditional stop. Trading XAU/USD and usdollar CFDs, I have found it more profitable to use a longer time frame. Currently, I trade the 1 hour chart. Trouble with this is that there is a lot of "noise" in 1 hour that can knock you out of the trade if you use a traditional stop. There is a real opportunity cost to this; not only have you lost the equity, but you also lose potential profit waiting to get back in again. Also, if you don't use a stop at all, you can easilly take a huge loss or lose everything to a "black swan". What I have been doing recently with the usdollar, is to enter a counter position where my stop would otherwise be. So if I am short, I go long at my stop. At worst, you lose what would other have been your loss if you stopped out + fees. At best, you profit in both directions. Furthermore, with FXCM atleast, this frees up usable margin. Therefore, you can in theory take a much larger position on a trade with a lesser fear of losing everything. Have any of you tried this and what has been your experience with this approach?
I'm not expecting anything. What I want is time to differentiate between noise and trend change. Using a hedge you can sit and watch for a while with a price no bigger than your original "stop" + fees. In the meantime, your margin has been freed to place another trade (With FXCM if you are short and long at the same time, there is no margin requirement)
What you can do to diffrential from the noise and trend are instead of entering two positions, you only enter when it break out from side way. For example, ES is currently in 1190, you can setup a long position that after 1200 or a short postion below 1180. In this case,you no need to pay any commision (or fees to those bucket shop) to open two positions.
Ok, that is definately a way to decide when to enter a trade. Now, you've gone long at 1200. It jumps to 1210, slides back to 1190 and hits your stop. Do you exit at 1190 and take your loss, or perhaps keep your long, and go short at 1190? At this point, you have locked in your 10pip loss + fees. Or have you? ES continues down to 1150, before gradually returning to let say 1180. You exit your short, take the 10pip profit. ES continues up to 1220. You exit your long and take another 20pip profit. Your worst case scenario here is that you lose 10 pips + fee*2. By the way, my profit expectation on these trades exceeds 100pips. The fee, which is the spread, of about 2 to 3 pips isn't excessive.
You can't hedge a position using the same instrument. No matter how many sub accounts you use to open both long and short positions they all consolidate into a net position. You are really just stopping and reversing, accumulating losses and fees. Hedge with options or another related instrument with different leverage profiles. ie. 2x and 3x ETF's against an underlying future position etc.
Why? In Time Frame X, usdollar trends up. In Time Frame Y usdollar trends down. Why can't you be simultaneously long in Time Frame X, and Short in Time Frame Y? Using this idea you can use a hedge instead of a stop. By the way, I agree with you if you are restricting yourself to one Time Frame. Thought of in a different way: This is a little like being invested in a stock and day trading the stock at the same time. You use a buy and hold approach believing that over the long run the stock will trend up, but in the mean time you try also to trade the price changes along the way.
Your strategy logic is independent of your net position. Just do the math... If your long 2 on time frame x in sub account A and short 2 in time frame Y in sub account B. You are just flat. Keep your strategy logic separate and just consolidate and trade the net position per instrument.
what you will find is that you will chase your hedge just as you'd chase your stop (or just get stopped out). its not going to be possible to place a pre-existing order for your hedge (because it would be marketable limit) so you will chase it, pay for taking liquidity or in FX just chase. Stop is better IMHO. Active, marketable stop is better than passive/idle as well.
Hedge or stop? Both are ways of limiting risk. It's all a guess as to which is better... no pat answers. Neville McJunkin.. any of you remember him? He used to hedge his positions, then take profits on the profitable leg. That still left him with a loser leg with which he had do something... Still a guess.