Grim and graphic content – PG 13.
Read this article only if you are truly interested in hedging.
It is not for the fainthearted.
Being a hedger is the financial equivalent of the heart surgeon.
If your trading relies on hedging, auto trading is your life support.
If your life support line is broken, your patient can die – this is the grim reality.
The life line can be broken by the stupid surgeon forgetting to attach the lifeline (not turning on auto trading), a power outage, a communications outage and the latter problem can happen at the end of the broker’s server – so much of the control is out of your hand.
A stop loss is a half answer for a non-local power outage (may or may not work), it gives no answer if the brokers server has issues, and in general is volunteering for losses, especially during low liquidity such as Sunday opens, news event turns, overnight trading and around re-balancing at the daily close. It is fair to say that stop losses can cause you unwanted losses, therefore aren’t suggested for use.
This calls for an alternative protection system, that is of hedging – this is a lot easier said then done.
The first step upon realizing how out of your control the whole environment is, that you would impose a cap on your losses by choosing the account size right: your total risk should not exceed what you can afford to lose => account size should not exceed 1% of your total wealth.
Hedging is a full time profession
I currently engage in two types of hedges: ratio hedge and RSI2 divergence box break hedge (a kind of a break out hedge).
The ratio hedges are provided by two different routines, one applies half/full hedges if the balance/equity ratio drops below 70% and 60% whilst the other applies full hedges at 50% and 40%.
The reason I do not try to hedge any more at 80% is that I’m using high leverage and excessive sizing – I believe in miracles, words and heavy doses.
I could not possibly produce gains like 182% in 6 trading days, if my sizing wasn’t a little on the aggressive side. Time spent in the market comes with the uncertainty factor that the human element starts overriding things based on emotions or illogical thinking prompted by bad interpretation of something that has not been encountered or is much too uncertain. You must pull out gains and do so frequently. Above 100% for sure in case of a 1:500 account, and at 40% on a 1:100.
The 70% and the 60% hedges as I mentioned, can at times be half sized, if their opening should happen against the tracked direction discussed in the previous articles.
The RSI2 divergence hedges have a 9-pip displacement beyond the far side of the last available un-stabbed divergence box found within a certain sample size.
When there isn’t such box within the limit, I put out a pending order at 1000 or 0 to have the required size for hedging calculated and displayed in the pending order list (especially helpful when you only have a cell phone to access the market with).
The number one problem with hedging is human error.
The human may close the hedge at the wrong time or may leave the life support turned off entirely.
The human is negligent, disrespectful and has bad habits.
To train the human to become a hedging-surgeon, thorough education is needed.
The human has to
– start respecting the patient’s life which is the funds on the account
– be able to distinguish among the different kind of hedges
– be trained for surgery situations such as amputations or other interference
An amputation is when a hedge was clicked on, it is in the right direction and an effort is needed to get rid of some of the excess fat – the toxic holdings. Upon any of these holdings come into money or show minimal loss, it is highly advisable to make the cut. This would help with weighting more heavily in the direction of progression.
Here comes the surgical precision part. The Hedger must be conscious that by opening up the balance, the auto hedging may immediately open the now missing portion back.
Although the corner stone of hedged trading is that the life support, the auto trading does not get turned off, for this kind of surgery, the button may have to be turned off before the amputation or imposing the chemical imbalance:
The same condition that opened the hedge the first place might still be on and if you do not first adjust the trigger (i.e. the ratio) you would end up with unwanted excess risk.
You must always think of the system as a whole and think ahead of what the consequences might be.
One basic principal of hedging that it should not add to an existing problem.
For instance, if you have adjusted down the hedging rate and this overlaps another hedging routine’s range, two different routines may end up coming to the same conclusion of having to hedge and you would end up first with a double sized hedge, which would suddenly be counter balanced in the opposite direction (given that the magic number is not in use), and the doubled size in both direction would be merely a best case scenario. By using the same magic numbers for routines acting alike you can minimize the risk of a doubling down, but at the same time may leave your flank open by disabling a routine from opening.
Preventive hedging is a sensitive topic within this sensitive subject. I do not currently use it, for it may cause more harm then the benefit it comes with.
Only if you are certain that your directional logic is correct should you consider engaging in preventive hedging, and at extremes / precise triggers (such as sharpie or an RSI cross down).
A relative of preventive hedging would be preventive opening, which is based on the same ideas, but would open a precalculated size position if there is nothing or less than the precalculated size is currently open in the opposite direction. This of course makes a leap into the offensive zone from the defensive one.
Overall I would suggest half size for this type of an open.
In conclusion, the ratio hedge would always have to cut manually, so it should never have a target or a stop loss.
The cardiograph of the Hedged Patient is the CI.
A hedge can be closed off manually when the following conditions are met:
– The 4H 7-sample CI is below 36
– A Red Tail was printed
– The current high is a 46-sample high / the current low is a 26-sample low (30 min candles)
The hedge would be closed with 1 micro lot being left behind normally to prevent from a re-open. The micro lot can be taken away later, when the hedging condition isn’t present any more (at a loss).
A break-out hedge can have a smart trail stop applied to it. A break-out hedge is o.k. to be closed out manually, if the conclusion is that the break was a fake-out.
How to adjust the ratio hedger via cell phone:
- Set up Google remote desktop (for free)
- Log in to your desktop
- Go on the chart window with the EA pegged to it
- For right mouse click use two fingers
- Choose Expert Advisors / Properties
- Choose inputs, edit the value next to Ratio