Actually, the hedge does provide a mathematically superior maximum profit! Here's why. Whether hedging or not the same result is achieve with two entries and two exits. The difference however is that with the hedge, one branch has ZERO risk. Again, I am working with the assumption that we are trading within a channel. Upper bound U, Lower bound L. C:[L,U] may be rising or falling or neither. Your entry with a short(s) and long(l), E:[s,l] is somewhere in that channel such that, s = -l. ( I think I represented this wrong in my last posting. ) Assume that you enter such that E is falling. Your short will profit along this whole path, s - L. Having achieved L, you exit your short. E:[l] now moves from L to U. Total maximum profit: s - L + U - L = s + U - 2L (corrected - sorry) Minimum profit/loss: E:[l]. The same thing can be achieved with a short at E:, and a long at L. However, your short at E: is unprotected. It is only protected if you assume the hedged position E:[s,l]. Unhedged, you assume the risk on both your long and short. Hedged you only assume one risk when you remove the hedge. There are no additional fees. This is a mistaken believe. In either case, it is a double trade. Also, while E:[s,l] is travelling to L, you have 100% of your margin available ( atleast, this is true with FXCM ).
Guys.. there is no free lunch You can put on a vertical options spread. I.e long a call and short a higher call. If the market moves in your favor then you will lose on the short and gain on the long therefore you don't gain as much. If you "hedge" in forex then its same as using a stop. You have to understand WHY you would want to hedge. An example might be you think the market will move higher but you don't want as much exposure to time decay.. so you use a vertical spread. There is no free lunch though. You might try to setup a options spread to benefit from time decay/direction but you will pay in some form. If there were a free lunch then it would already be taken.. Remember what I said, the reason I "hedge" is to buy time to stay with my position or scalp, i.e profit from volatility. The risk is the same as if I were to close the one position and open the other position, i.e reverse for a time. The only thing I gain is reduce slippage and commission. But again if I'm wrong about reversing then I've a "hung hammer" or "failed hammer"... basically just a bad trade. "hedging" in same instrument is same as reversing/closing out.. the only reason you would want to do that is if you wanted to trade the micro swings while keeping a long term bias. It could work but you're long term bias is wrong then you will lose more then you can gain from scalping/trading the swings. And, if you are right then you are entering into trades that you would believe are set to go bad.
Forget about spreads and all the other traditional methods being taught, you need to look at it from a different angle and use prudent risk management that goes against what you know.
generally sounds like you guys are in over your heads and need to blow out and take losses before you start thinking about hedging. If you hedge and then take it off - only to wait for the first leg to "become profitable or less of a loss" then you have done nothing but pay your broker more comish. keep tighter stops and accept your losses when they come.
Exactly. Precisely. Completely. At some point the pseudo 'hedge' comes off and you are running a naked position.
I think there is a false sense of security when you just put it on and set a stop. True, you know what your max loss on tha btrade may be, but you don't know what your max loss on hundreds of trades will be. Sometimes introducing the hedge or spread can give you some staying power you may not otherwise have. It's a toss up between hedging or just trading smaller.
I think that is where I am seeing the greatest use for hedging with the same instrument. It locks in the loss but offers the chance to reenter the same position. Yes, you can just take your loss and reenter with a new trade. However, now I say: what is the difference? In either case you're paying for two trades. In either case you are waiting for an appropriate new entry point. The advantage of the hedge in this case is simply to protect you from an anomoly - a sudden sharp move of the price against you.
The reason why this is all being discussed is psychological. You just don't want to be wrong!!! Put on a trade and then place a stop at a point which proves you are wrong may be a better approach than hedging and all this nonsense.
Agreed. Plus you're going to be using up a lot of emotional capital on the trade. So be smart, don't try to get clever, ie - 1. You put a trade on 2. It didn't work 3. Take the acceptable loss, and then 4. Move on to studying the market/price ready for the next trade