Why Hedging in the Right Spots Will Make your Returns Jump
Hello, traders. Welcome to the Pro-trading course and the sixth module, “Hedging.” In this lesson, we are going to learn why hedging in the right spots will make your returns jump. And it’s pretty simple actually, so we are going to go to the charts and look at the same example that we were looking on the US dollar/Japanese yen short position. You remember that we were short on the US dollar/Japanese yen, and that we could have hedged either with a lump position on the Euro/Yen or if your broker is allowed to, with a long position on the same instrument, the US dollar/Japanese yen.
Now, we are going to do the math on both situations. Let’s imagine that you are in short and you are still…well, your bias is still short here from the 109.83 level. This means that you have taken on the first part of your position 216 pips, and by hedging against a move against you of more than 50% so you are going to be gaining these pips too. Let’s just draw a Fibonacci Retracement tool and let’s see if we are in fact above the 50, and as you can see, we retrace more than the 50%.
I’m going to delete the Fibonacci Retracement tool because we really don’t need it for this lesson, but I wanted to show you that a deep retracement can hurt your open P&L a lot. So actually from this low to this high, we retraced 145 pips. But because we don’t know for sure if this is going to be rejected, we cannot enter out the exact area. So we are going to wait for our rejection candle and our rejection candle comes right here.
We went long at the 107.98 level and the…well we close our hedge when we saw this particular rejection or double-top right here just below the 109.10 level. When we saw this double-top at the 109.10 level, we closed our hedge because this means that, well price was just retracing back before bursting through the 107.65 level which in fact is doing right now. We can see that price is pushing down very strongly right now.
So when we saw this, we closed our hedge and from the entry to the exit we actually made 95 pips. So I’m going to grab the tool here and I’m going to put on the 95 pips that we made from our hedge, all right?
Now let’s assume that we didn’t have a hedge on, and what would have happened is that we would have made 216 pips, we would have waited out this retracement and now we would have been at our first target without cashing in on the 95 pips to the offside. So by hedging, we are not only just protecting our short position on the US dollar/Japanese yen against the move against us, but we are also cashing in on a move against us. And if price would have broken with the 109.10 level and hit our stop-loss and continued higher, well we would have cashed in for 216 pips on the downside and we would still have a long position open for another 180 pips.
So basically by hedging at the right spots, you are going to make your returns higher and you are going to improve your win rate and your returns are going to be much, much higher.