Hedging trades in a trend direction

[raa]

Hi guys.
As we all know psychology plays a major role in a trading business. While it is absolutely necessary to maintain cool head and regard trades mere as chance plays with ultimate odds in your favor, it is still painfull to watch either trade going wrong and accomulating loss, or seeing it being stopped out with estimated risk but market to turn around.

There is another thing to concider here: position size and stop-loss size. As per sound money management rules we have a certain percentage or fixed amount to risk on trade and that is not changing however big or small stop loss is. However it's clearly understandable that generally bigger stop-losses tend to have less trades being stopped out before market reversed and gone in original direction. But the bigger stop loss, the lesser position and potential profit.

I hope you are still with me!

Since I have abandoned my malicios practice to average down position when going wrong, I have found out that I have lesser number of winning trades that I used too. Of course latest silly markets also play a part.

So it made me think how to kill several birds at the same time: have a sound position size without a small stop-loss that would be triggered with a bigger chance; not watching your trade going wrong and accumulating minus pips in pain; not watching market to reverse after a position been stopped out.

It made me think of a specific strategy for a trades in direction of a trend, when you feel there is much more change that the trade eventually will go this direction that other (so it is not for counter-trend trades).

The strategy would be using hedging trades opened for the same position as original trades placed at the level where first preferable stop-loss should be. I.e. that would be normally at a smaller distance than a more cautious stop-loss would be placed, allowing a bigger position.

So far a have come up with a following procedure:
1. Plan a trade in a trend direction at the level your system dictates (support/resistance, Fibo, trend line, LMT, etc)
2. Plan a level where would you put you either put your stop-loss, a level which would signify that your original level is broken, i.e. support or resistance did not hold, etc. That should not be too far away, I recon around 50 pips max off H4,D1 charts.
3. Put an order for a hedge trade with a same as original position size at that level, obviously a trade is an opposite direction to original trade
4. Put a stop-loss for a hedge trade somewhere between half distance from original entry to hedge trade entry and original entry, i.e. between 25 and 50 pips.
5. Put a trailing stop for a hedge trade for 20-30 pips or a break even at 20-30 pips.

Additionally for a pull-back entry trades off Marc's M2 system following steps may be added:

6. Select a next level of support/resistance, Fibo level, etc where would you put a trade in original direction if market would pull back that far.
7. Put an additional position to add to original one in original trade direction and in a trend direction
8. Repeat step 2 but for a resulting position
9. Put a hedge trade for a resulting position at level set at step 8 and use same rules for hedge's stop-loss, break even and trailing stops.
10. Do not add more to original position or repeat those steps again.

Of course, hedging is a basically an insurance, like a swap in a bond market or a put option in an equity market. So it comes at a price. But like an option or a swap, it gives you possible unlimited profit for a fixed limited price. In our case the price would be if market would stop, after you open a hedge trade and reverse to original trade direction and a hedge trade is stopped out. However, if a market went more further counter-trend, you have a chance either to have a hedge trade stopped out at break even, or stopped out in profit at next possible entry level, where your expect market to resume a trend direction.

I would love to see your comments over this strategy, additions and corrections, and if you decide to test it - you are welcome as well as your thoughts and experience reviews!

Thanks!

[raa]

I will add a live example of this strategy use, a trade I am in right now:
1. After a EURUSD break out from triangle/small uptrend during this week, and a pull back to 1.3265
I have put a position for a breakout continuation below previous break out low at 1.3138 short.
2. Market has triggered it yesterday but had reversed again to 1.3220
3. Originally I had a stop at around 100 pips, which was close to be triggered, but decided to try this tactics.
4. I put a long trade for the same position size at 1.3225 with a stop at 1.3197
5. I put a take profit for a hedge trade at 1.33
6. I put another short order at 1.33 which is a strong resistance level which tend to reverse price downwards to original trend direction.

After I have written this my hedge trade was stopped out and market seems to be reversing to downtrend. I took a loss of 37 pips instead of 100 pips.

If I would plan to use hedging from the beginning, I would put a hedge order entry at 1.32 and a SL for the hedge at 1.3165, and my maximum loss would be 35 pips, however with an upward move of 40 pips from 1.32 we had my hedge would be stopped out at break even with no loss.

[raa]

A little update. I have tried this method several times by now, it does work but have one big flaw: when a counter-trade bounces, it may not go far enough for stop-loss to move in and back off, growing negative pipage, or, even more often case: it gets stopped out by moving stop loss but then goes again in the same direction. It requires constant manual monitoring and frequent trade re-opening. If done like this it works. But it is VERY time consuming and little bit depressing. One possible option is to develop EA, that will close counter-trades with zero profit when price bounces back before moving to some reasonable level like 15-25 pips at least, and most importantly, will re-open stopped out trades. It would solve not all but most issues with it. One last issue that will still remain (and it is a price to pay) is when price move enough to open counter-trade, but never goes even to few pips profit, backing off. Then it has to be stopped out at some level, to be re-opened again if price moves again in this direction.. Sounds complicated but should be something quite basic to develop. I am looking into this direction.

[capsmart]

Hi Raa
I just purchased the robot that will solve all your problems and make you rich in one night. I am joking of course. But I got the 4xCashCompounder that is doing what you describe the moment you fire it. It will go long 0.01 lot if price moves to 60 pips profit it will close the trade, if it goes against it for 20 pips it will open a trade in the opposite direction with 0.02 lots. If now price moves again up more than 20 pips then another long trade is fired with 0.03 lots. The next one is 0.05 lots then 0.08 etc. The system multiplies the previous entry by 1,618 (fib) and keeps doing this till the profit target is reached. It looks like a martingale and this is why the author allows you to turn this procedure off. I installed it yesterday and so far I have 2 winning trades on a demo. I want to try it for some time before I put real money in it because I am not convinced it will not blow the account when something extraordinary happens. There are practically no money management rules like "Risk no more than 1% of my account" because the robot will keep generating entries with as much as 10 lots or more.

[raa]

Sounds interesting, keep us posted. My method (which I am extensievly testing) is more like an insurance for trade entry (too early or skipe through the stop and back), rather than a trading system of any sort. So far my experience is that it may be very worthy for range and channel trading.

[capsmart]

So far I had 5 out 5 winning trades and my demo account increased by 12% in 2 days.
Of course I will have to keep it running for some time before I put real money in it.
I emailed the author to tell me what is the worst case scenario. I am always afraid to use a robot that has not risk percentage.
I have to admit that he answering all my emails within hours and they are not copy - paste answers.
My impression so far is very good.

[raa]

So what is the worst case scenario? Can you post a link to the vendor?

[raa]

PS from what I understood from your explanation, this is basically a grid trading robot, in a ranging market I assume this is a bullet-proof technology. But with a strong trend and completely new grid (i.e. range) there will be floating losses that can hang there for years.

[capsmart]

Ok let's go once again.
The more I use it the more I understand how it works
First let's say it will buy 1 lot (it is 0.01 for a 5000 account and always eur/usd because of small spread)
Then price goes down 20 pips or more. At the 20 pips level it will generate a short position of 2 lots. Now price goes up again 20 pips. Our first position is at break even but our second is loosing 20 pips. It will now generate a long for 3 lots. If price goes down for 20 pips then
Our first entry and third entry (1 + 3 lots) are loosing 20 pips but our second entry (2 lots) is at break even. At this moment a new short for 5 lots is generated. Now lets say price continues down for 60 pips. At this moment all the trades are closed. So we have our first and 3rd entry (1+3=4 lots at -80 pips) but we have 2nd and 4th trade (2+5 lots at +60 pips)
The result is -320 pips +420 pips. Net 100 pips. Of course you have to consider spread in your calculations. The author says that it is good to have a fixed spread broker.
So the worst case scenario is when price keeps ranging in those 20 pips long enough to open many positions where the losses of 20 pips will be so big that will ruin your account.
So far I have 5 out 5 winning trades. The first reached 1.44 lots after 11 positions in 14 hours and another one also created 11 positions in 24 hours. The other 3 trades closed much sooner. So it is good when prices move. If you will have one 60 pip move during the day the trades will be closed.
It is also important to close your trades on Fridays to avoid gaps. Imagine having a position and then price gaps 60 pips against you.
You must also use a VPS to avoid down time. This could also be critical due to lot size.
It is a system that you have to monitor every once in a while and if you see that you have too many trades open to try to close them at break even when price will be somewhere in the middle of the range and start all over again.
In theory you could do it manually yourself since the system after opening the first trade will automatically create a pending order for the next move but the robot does all the calculations and it is better, faster and more accurate.
As soon as one set of trades is closed another one starts again unless you tell the robot not to. Actually this is the only parameter you can change.
I hope that my long explanation is clear enough.
Please think about it and let me know your opinion.

[capsmart]

From some calculations concerning the hedging system after 18 positions you will be long 41,8 lots and short 67,64 lots so your net exposure will be -25,84 lots. So 20 pips on this will create a margin call on your account.
I emailed the author with the same calculations and explanations and will wait his reply.