How do hedges work actually?
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Thread: How do hedges work actually?

  1. #1
    Hi traders,

    I've a question which I would really like answered. How do hedges work and how do you discover what to hedge?

    I am curios because frequently, trades will go against you. So what I end up doing is hedging on the same pair. In theory, all you need to do is find the right time to unhedge and you will begin earning money. So that first mistake isn't too much of a liability.

    The challenge is: should you understand when to unhedge, you wouldn't be in this situation in the first place (since you need to be able to ascertain where the price is led )

    I understand hedges get the job done. People all over the world use it in order to manage risks. But how does this function? And how do you qualify a pair (or multiple pairs) to hedge? More importantly, how do you use it to generate income?

    Can any experienced traders edue me please?

  2. #2
    Are you sayong that you cant hedge in forex?

  3. #3
    Sure you can, just don't use 2 spot currencies. Using the identical tool to hedge itself is the simplest way to exchange contrary to yourself.

  4. #4
    In finance, a hedge is a position established in one market in an attempt to offset exposure to the price risk of an equivalent but opposite duty or position in a different market #8212; generally, but not necessarily, in the context of somebody's commercial activity. Hedging is a egy designed to minimize vulnerability to these company risks because of sharp contraction in demand for one's stock, while still allowing the company to profit from making and maintaining that stock. A normal hedger may be a farmer with 2000 acres of unharvested wheat at the floor, who would rather tend his harvest without the distraction of cloudy prices. He is a farmer, not a speculator, however his unharvested inventory may have lost 35% of its value ($285,000) from the three months he has been planning his planting. He may have decided he could live with a price of just eight or nine dollars a bushel, and to cancel his implanted position having an approximately equal but opposite position in the market for wheat on the Minneapolis Grain Exchange by purchasing ten wheat futures contracts for December delivery. This farmer is consequently a hedger indifferent to the movements of the market as a whole, and has significantly reduced his price risk into the gap between the price he'll get from a local buyer at harvest time, and the price at which he will concurrently liquidate his duty to the Exchange. Holbrook Working, a pioneer in hedging theory, called this egy speculation at the foundation,[1] where the foundation is the gap between today's market value of (in this example) wheat and now's value of this Dollar. If this difference widens, he makes a bit more at harvest period. If this difference narrows, he makes a bit less. He has mitigated, but not eliminated, the risk of losing the value of his wheat as of this afternoon he created his hedge.
    Some form of risk taking is inherent to any business activity. Some risks are considered to be natural to certain businesses, such as the risk of oil prices rising or decreasing is organic to oil drilling and refining firms. Other forms of risk are not wanted, but cannot be avoided without hedging. Someone who has a shop, for instance, expects to confront natural risks such as the risk of rivalry, of poor or unpopular products, etc. The risk of this shopkeeper's stock being ruined by fire is unwanted, nevertheless, and can be hedged via a fire insurance contract. Not many hedges are financial instruments: a producer that exports to a different country, for instance, may hedge its currency risk when selling by linking its expenses into the desired currency. Banks and other financial institutions utilize hedging to restrain their asset-liability mismatches, such as the maturity matches involving extended, fixed-rate short-term and loans (implicitly variable-rate) deposits.
    A hedger (such as a manufacturing firm ) is thus distinguished by an arbitrageur or speculator (such as a bank or brokerage firm) in derivative purchase behavior.

  5. #5
    Okay, the question is how can you use hedging to generate income?

    Take hedge fund managers for instance. They market themselves to limit risks and yet are able to earn money. I don't know how this works.

    Also, they hedge on the exact same instrument. Eg: they could brief and long a stock at the exact same moment. I do know they brief and long different stocks. But they hedge on 1 tool.

    Can the same be implemented in Currency Market trading?

  6. #6
    Quote Originally Posted by ;
    take hedge fund managers such as. They market themselves to limit risks and yet are able to make money. I don't understand how this functions.
    Let's say I feel a stock is going to go a lot. I could also buy some set options incase it goes and I'm wrong. The question is whether you recoup the expense of the options. In otherwords options themselves convey no advantage, you have to have a fantastic egy first. Clearly you're several light years out of that at the present time.

    Quote Originally Posted by ;
    can the same be applied in forex trading?
    There are currency options, but they are fairly weak at the moment. You could try gold against the US dollar perhaps, but that's developing a spread.

    Frankly I really don't believe forex is a fantastic market to get a hedge pair, but you could buy currency options to hedge against a negative move if you're so worried.

  7. #7
    If it is not possible to mitigate that risk in FX, how do professional FX traders handle their money? It cant be just straightforward buy/sell with stop loss. That's only trading half naked.

    Where can I go to learn more egies? Or if anybody is willing to, then post here the way you do it?

  8. #8
    Quote Originally Posted by ;
    When it is not possible to mitigate that risk in FX, how do professional FX traders handle their cash? It cant be just simple buy/sell with stop loss. That's only trading half nude.
    Why not? Control lot sizes, enter appropriately, use an proper stop loss. You do not need anything else. Simple is great. Either you've got an advantage or you do not.

    Complex hedging egies do not typically mitigate risk, they simply increase it in some obscure way that's easy to forget about.

  9. #9
    Quote Originally Posted by ;
    okay, another question is how do you utilize hedging to make money?

    Take hedge fund managers for example. They market themselves to limit risks and yet are able to make money. I do not know how this functions.

    Also, they hedge on precisely the exact same instrument. Eg: they could brief and long a stock in precisely the exact same time. I do know they brief and long different stocks. But they still hedge on 1 instrument.

    Can the same be applied in Foreign Exchange trading?
    They call the leadership right, but utilize the hedge to limit their risk. Regardless of what you trade, where you go, it's literally impossible to have a perfect hedge. In FX, even in the event that you market and buy the exact same specific currency in the exact same precise time, you will still be down disperse to the two positions, and negative roster will be greater than positive roster, which means you'll get a negative posture. Hedge funds utilize things such as stocks, futures, and options to hedgefund. Like mentioned previously, they utilize two different types of instruments.

    By way of example, let's choose a farmer who has a crop of lima beans and he also thinks the price is going to drop before he sells them. He wants to hedge his crop to ensure if it does go down, he wont lose as much money like he had been in a hedge. So essentially, the farmer is long on his lima beans (since he has them now and intends to offer them afterwards ) this is called a money position. In order to market, he is going to sell (short) lima bean stocks. Now, because of the difference in the positions and contract size limitations, this will be a great hedge. He'll still likely have a bigger exposure on his crop compared to on his futures contracts. Let's pretend the price does go down and say that the farmer dropped $15,000 on his own lima beans and won $14,000 on his own futures contracts. Instead of losing 15K, he lost 1K.

    This exact same principle could be applied precisely the opposite way in order to generate money. If the price had actually gone UP, the farmer would have MADE 1K rather than losing it.

    That's how the big funds do it. They market their positions in order that they get a more compact loss/win than they want an unhedged position.

    Hope that this helps

  10. #10
    Right, since there's a time lag between the decision to generate soft commodities and also the time in which they may go to market, this creates uncertainty for the farmer. In order to lessen risk he can have a brief position to an equal value of this current market price of the anticipated harvest, effectively locking in todays price. If price goes down he'll earn less on his harvest however, the futures contract will probably have appreciated. If price rises he'll lose on his brief position but then his crop will command a greater price in the market. Perhaps interesting to know but of limited use for a trader. If your account remains in different demonination to the currency you use and you are unsure about future exchange rates, you can'lock-in' todays price by taking an equal and opposite place.

    I've heard some professionals utilizing hedges on comparable (although not identical) market instruments in expectation that the values will converge at a certain point in the future, so that they brief one and long the other. Since the correlationship between the two is so close, when one rises the other almost always can do too, and vice versa when market values depreciate. They are just gambling on the gap between the two to close.

    Long Term Capital Management were utilizing an example of the fixed income arbitrage on government bonds, where they'd indentified some discrepancies which they sought to profit from - but since the differences were so small, they had been leveraged to the hilt on these positions. This was not a problem until it went tits up and they lost a shit load of money and needed bailing out. They had made some faulty assumptions about what could happen, believed they had all of the risks sewn up in their version, entirely underestimating the possible effects of unexpected events on the market. Hedging as way of decreasing risk doesn't necessarily work out that way.

    There are perhaps a few similarities to be drawn from hedging in a retail forex account if you are restricted by the total amount of margin your broker will offer you. Basically your funding has been tied up when the majority of it is acting as a counter balance to the opposite side of the hedge, which makes no difference unless your broker decides to shut out the shedding position to satisfy with the margin requirements in your account. I haven't really spared that scenario much thought since I do not hedge but it is among the chief reasons that the US government plan to outlaw the use of hedging in retail forex, as well as the charging of unfavourable swap rates.

    In short, I'm yet to determine how hedging may be incorporated into a profitable egy besides utilizing the exceptionally complex arbitrage procedures. More likely it is a policy employed by amateur traders who aren't plogically capable to take their losses and put the pain on hold by placing a position in the contrary direction.

    Hedging might seem complied and complied and you could be forgiven for coming to the conclusion that utilizing complex and complex approaches will lead to riches. That is not my experience - easier the better. If you're bullish proceed long. If you're bearish go brief. If you're unsure then stay out until you are.

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