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Hedging in FX is a somewhat complex business, often requiring not only immense skill but also the correct platform and associated software.
In this Guest Editorial, Eugene Potapov, Business Development Manager at Emet Trading Solutions details his methodology for mastering hedging in today’s technology-focused markets.
Emet Trading Solutions is a company which provides an entire spectrum of services for programming customized automated strategies, expert advisors, indicators, and scripts for various trading platforms. The firm is also a certified consultant of NinjaTrader and cTrader. The company’s services are designed for traders, brokers, and financial analysts.
In order to explain how inexperienced traders’ predilection for hedging reduces their income as well as to show how simple strategies that do not require any “market sensitivity” or “magic” detectors can generate a steady income, it is important for us to detail factors involved, and their potential solutions.
What is hedging? This concept involves what is called an offset position. Let’s consider some examples.
Let’s suppose you already have a Market Order to long (“Buy”) or, that is to say, you have already opened a long position. This order may sometimes seem to be already outdated, but you can open an offsetting position instead of closing it, which will be focused on lowering (“Sell”) and be called a short position.
If an opposite position is opened with the same amount of investment as the first one, then loss on a position for any price movement will be to balance the gain on the other. Thus, you get frozen capital in your account and a reduced investment in new orders, which would bring you income. This action is called hedging.
The above diagram shows an inexperienced trader who has attempted to save an ill conceived “Buy” order with an opposite directed “Sell” order. By applying the hedge in such way, a trader can only freeze capital.
Let’s deal with some technical considerations before explaining further. Understanding the technical details are particularly beneficial for the modern trader. You can learn to “feel” the market only through long-term experience, and not everyone is able to find the “magic” indicator on the internet for free, which would be a bold arrow indicating the direction in which your investment is going. Accordingly, there is nothing better than finding out where the market itself is ready “to drop a bunch of gold coins” because of its technical features. You can often make substantial gains within a single trading operation by correctly defining the proper moment and skillfully using hedging.
Technical approach to the trade: The key to success
But let’s start, as it is necessary in the formation of strategies, at the end: If you already have two opposite orders, how is possible to close them? Traders all over the world are changing brokers in pursuit of the narrowest spread, which is the minimum difference between the buying and selling price. They learn how to do this from many years of experience, and it will be most unwise to neglect the possibility of reducing the spread. By the alternative closure of two opposite orders, you lose one spread from each of them. That results in the loss of two spreads.
The MetaTrader4 platform allows you to close a hedge with the loss of one spread by using a special “OrderCloseBy” method, but doing this is only available to scripts and advisors. Access is closed through the user interface.
It is not surprising that to multiply capital, you may need some tools from scripts, advisors, and indicators. You must be very careful when ordering the elements of this toolkit, as your gain or loss may directly depend on instrument quality.
An important tip: Use only approved manufacturers of software products that have a tradition of high quality and maximum experience. Only in this case can you be sure that the software will be the most focused on your needs. Otherwise, by choosing a developer haphazardly, very often you may experience a loss simply because the skills of your developer were not controlled by anyone.
Although some sources originally recommended that an opposite order should be opened when the price moves in the wrong direction, doing this often leads to the loss of capital, and thus the inability to make a deal at the right time that could bring a tidy profit. You should close a bad buy, wait for a price reversal, and then open again. That’s what the majority of experienced traders do. Trying to close the hedge without any loss rarely succeeds and takes a lot of time, often resulting in substantial cost both for traders and trading robots. Errors are simply inevitable in any trading system, but we must strive to divert resources as minimally as possible. Only in this case does the trading system have a chance to be effective.
However, it is now time to move away from criticism and warnings to discuss the opportunities and benefits of hedging, which offers many opportunities.
Hedging in scalping
Hedging in scalping can be very effective. ECN accounts are commonly used for scalping because they first provide a very narrow spread. Additionally, the possibility of a broker to trade against its clients is often excluded. Unfortunately, there are drawbacks associated in almost all accounts with a narrow spread. As an example, if a broker expands the spread slightly for a short term at the exact moment when it is necessary to close profitable orders for “Stop Loss” or “Take Profit.” The result is that although the spread is low most of the time for you it is much higher. In such circumstances, of course, it’s not the best way to approach scalping.
Let’s say you select an appropriate account for scalping and the broker a-books all of its order flow, providing access to a wide network of liquidity providers. The main feature of a good A-book account is that new quotes will come to you in the terminal 300–1,200 times per minute in the active trade. In such conditions, it can be quite problematic to place an order manually, even with high-speed internet connection. Of course, you can simplify your task of an order opening by agreeing to slip, but to meet the challenges of scalping, those items that you thus lose can often play a crucial role—while having a narrow spread, you cannot take advantage of it.
Let’s look more closely at the situation. If we compare the bars formed on an ECN account with the bars on a regular account, they will appear only slightly different. The main feature is active price movement within a bar.
It is this movement, if you are able to use it, that is a great source of income that does not require anything other than a technical mastery approach to recovery.
In tracing the work of accounts which are being executed on an a-book basis, you may find that usually only some of the ticks are processed by the trading terminal. You do not even have time to extract revenue from these oscillations, if only all trading operations will be reassigned to the trading server. There is such a possibility, and it is unique. The terminal should send a pair of pending orders to the server on both sides of the current price—a “Buy” pending order and a “Sell” pending order. In this case, “Buy” should be below the “Sell.”
When the price during the chaotic oscillations turns both orders into market orders, they should be closed back-to-back by using the “OrderCloseBy()” function. The difference between the opening price and the warrants will be your profit. From one pair, this profit is minimal, and it is unnecessary to try to make it greater than the spread. When moving the price for one bar minute, you can close 10–20 such pairs, but and in quiet conditions, this strategy works very well indeed.
This particular chart shows a simple grid of a dozen pairs of opposite orders, which are arranged in pairs at a distance of two spreads. The blue dotted line represents “Buy,” and the red dotted line represents “Sell.” For clarity between pairs of orders in the grid, an interval of one spread was left.
In a real trade, there is no need for this, and it degrades strategy performance approximately twofold. Even so, it is clear that in just a little more than a day, over 50 pairs of orders can be closed at a profit. If you put the pairs closer together and partially overlap, this may prove useless for trade day can be closed with a profit of up to 150 pairs of opposite orders, significantly having increased their capital as with such trading scheme minimum resources were required to maintain open positions.
A strong presence of the trend motion causes a detrimental effect on this strategy. Referring to the “Sell” order mentioned above, the price can transfer it into the category of the market and move up, leaving a pending “Buy” order below. A loss will accrue when the active trending price may exceed the income even from a dozen pairs of successfully closed orders. With this in mind, you should take necessary precautions. Of course, if there is a strong trend motion, then it is difficult to make a profit, and it does not require complex strategies. However, the trend motion can occur unexpectedly. To limit losses in the rapid output prices of the price channel, it is recommended to put on its borders protective safety orders: “BUY_STOP” on the top and “SELL_STOP” at the lower boundary. With such precautions, these orders will usually bring additional revenue to the one that is formed inside the bar.
A loss occurs only if both protecting orders will be converted into the market because of up-and-down sharp price swings, but it is difficult for this loss to surpass the income from a dozen pairs closed within the bar orders.
It’s quite convenient to display and adjust the boundaries of the price channel specifically written in script for this strategy and the formation of pairs of pending orders passed on to the advisor. Thus, it is possible to earn an income at once on multiple currency pairs. It should be just in time to tinker with the boundaries of the channel and stop the advisor’s work when news is published. Despite its advantages, this strategy has a downside. Appropriate ECN accounts are not available when investing less than $1,000. Therefore, in the next article, we will discuss a strategy that allows starting with the minimum investment required to enter this minimum level of ECN accounts.
1. Hedging does not have a safety mechanism if you make a mistake.
2. The modern technical tools available to traders can significantly increase revenue opportunities.
3. There is no need to be idle during a calm period in the market. Despite the lack of trend motion, you still have an opportunity to receive high dividends by using high quality trading tools.
4. Hedging efficiency depends directly on the code quality of supporting and basic programs that are used in trading, so it is especially important to order them from a reliable and verified service provider.
This is a Guest Editorial written and compiled by Eugene Potapov, Business Development Manager, Emet Trading Solutions, who can be contacted at [email protected]