I stumbled down the hedging path in around 2011.
(Yes, you can do this in a US account, I'll show you how later in this post.)
A couple of months after I started experimenting with hedging, my friend asked me to teach him how to trade Forex.
But there was one condition…
He wanted to learn a strategy that was super conservative. Something about making it easier to explain to his wife.
Fair enough.
I saw the potential in hedging, but it still needed more forward testing.
So I told him that I have a method that could fit his criteria, but it still needs some testing.
I welcomed him to test it with me…
Even if it didn't work, he would learn the basic concepts of Forex trading, get practice executing trades and gain a better understanding of what type of strategy would suit him best.
He was game, so over the next 3 months, I went over to his house 2-3 times a week and we traded the London open. He traded a demo account and I traded a small live account.
…and guess what?
We both made money at the end of…every…single…month.
(past performance does not guarantee future results)
At that point, I was confident that it worked and my friend had a firm grasp of the concept, so we stopped meeting up.
I traded it for another 3 months and I was profitable during those months too.
Then I stopped trading it…cold turkey.
Later in this post, I'll share with you why I stopped.
I'll also share why I started trading it again. But before that, I'll show you the method and help you figure out if it is for you or not.
[toc]Is Hedging For You?
But enough about me, is hedging for you?
It depends on your personality.
Unlike other traders on the internet, I will never blindly tell you that any one trading strategy is the only one you need, because that is simply not true.
The key is to figure out your Trading Personality first, then learn strategies that are a good fit for your personality.
It's like driving a Ferrari…not for everyone.
It's a small shift in where you focus your attention, but it can have a huge impact on how quickly you progress as a trader.
You can spend years spinning your wheels and chasing shiny new trading systems or you can become more aware of what you are good at in the beginning and focus only on those types of strategies.
So if hedging is something that resonates with you, then keep reading.
However, if you still think that hedging is dumb, then stop reading now and go find another strategy. I won't be offended.
Also remember that this is the way I trade it. There are many other different hedging methods out there.
So if you see a way to improve on this idea, go for it!
The Biggest Benefit and Drawback of Hedging in Forex Trading
If you are considering using my Forex hedging strategy in your trading arsenal, then you need to understand what you are getting into.
Regardless of what you have read before, there is no such thing as a “sure-fire” way to profit with hedging.
There are no free lunches in trading.
Every benefit of a trading strategy has a corresponding drawback.
Biggest benefit of hedging: Consistent returns (when done correctly).
Biggest downside of hedging: Low returns per month, so you need a fairly big account or trade for investors if you want to trade it full-time.
Alright, if you are still reading, then you are probably into this kind of thing.
…or at least you are curious.
Before I show you my hedging method, let's get a few definitions out of the way. If you already understand these concepts, then skip down to the section on The Core of My Forex Hedging Strategy.
What is Hedging a Position?
Hedging is when you hold a long and short position in the same currency pair, at the same time.
This may not make sense at first because you don't make any money if you do this. But hedging can be a great way to limit your risk, while the market figures out which direction to go.
Once the market “shows its hand” and starts trending you can start to profit from your winning trades and minimize the losses from your losing trades. Partial hedging can also be used to reduce your loss if you are wrong about a directional trade.
Why Hedge?
The bottom line is that nobody knows, with 100% accuracy, what the market will do next.
Therefore, holding long and short positions at the same time can allow you to profit from price movements in both directions.
If you use my method, you can also profit while you reduce your exposure to your losing trades.
How to Hedge in a US Account
This video is a little old, so bear with me. The concepts are exactly the same, just the platform is different.
Instead of using the Java platform, I now use TradingView.
The result is the same…you can get around the hedging and FIFO rules.
So if you live in the US, you can do this too.
The Core of My Forex Hedging Strategy
I call my Forex hedging strategy Zen8.
It is super flexible and there are a ton of nuances to this method. I will share these details with you in later blog posts.
But in this introductory post, the most important thing that you can learn is the simple concept of the Roll-Off.
This is the core of my Forex hedging strategy and this one idea alone is very powerful.
Here's how it works:
When you close a winning trade, you will Roll-Off 50% of your gain from your losing trades.
So you still take a loss from your losing trades, but you do it at a net profit.
To get the complete guide, download the PDF here:
Roll-Off Example
For example, if you closed a long trade for a +$500 profit, you will close, or Roll-Off, a -$250 loss on your short position immediately after you close your long trade.
This way, you will still have a net profit of $250, but you will also reduce the lot size of your losing position.
From there, you can put on another long position to hedge your existing short position. Since your short position is now smaller than it was originally, you have successfully reduced your risk to further adverse moves.
Then you keep working back and forth between hedging and doing Roll-Offs until you are able to close all trades.
Your goal in Zen8 is to get completely flat or have no open positions. This allows you to take a break and find a good spot to get back into the market again.
Benefits of Zen8 Over Other Hedging Methods
Other hedging methods will take more trades (or even double down) to offset losing positions. In my opinion, that is the worst thing that you can do because you will eventually get stuck with a huge losing position on one side of your books (buy or sell side).
I've seen a couple of high-profile hedgers go down this way.
But if you are diligent about doing your Roll-Offs and continually reduce your position sizes (even if the profits are small), you will be able to keep your risk low and your returns consistent.
How to Get an Exact 50% Roll-Off
At this point, you may be wondering how to Roll-Off exactly $127.32.
The answer is nano lots. They allow you to custom tailor your hedges and Roll-Offs, even with a tiny account.
If you start trading a large account, then you don't have to use nano lots. But until then, I would highly suggest that you use them because they give beginning traders a huge edge and makes this hedging method possible in a small account.
How to Get Started with Zen8 Forex Hedging
This trading method can be backtested. But this is one case where I believe that it's actually more beneficial to open a demo account and start beta trading it as soon as possible.
To get maximum benefit, you should do both at the same time.
Backtesting works very well when you have a defined set of rules for entry, exit and trade management. However, given the highly discretionary nature of this trading method, I believe that it's far better to just dive into it.
How will you know when you are ready to stop trading in a demo account?
That's entirely up to you. But I believe that a good rule of thumb is if you are able to get yourself out of a bad situation at least twice, then you are probably ready to go live with a very small live account.
I would define a bad situation as having a position that is down 500 pips or more. You learn a lot about how to be a good hedging trader when you are stuck in this position.
You might even consider putting yourself into this situation on purpose, so you understand why should should avoid getting too far in the hole.
Which Pairs to Trade?
It can be tempting to trade several pairs at the same time.
I've found that sticking with one pair is the best way to trade Zen8…at least in the beginning. This gives you enough margin to safely work your way out of trouble.
You can trade whichever pair you are most comfortable with. However, I would suggest staying away from pairs that have a large spread or are highly volatile.
Where to Enter the Market?
In reality, it doesn't matter. That's the beauty of hedging.
Seriously.
Hire a monkey to pick your entry point. Have your kids pick an entry. Use Tarot cards.
I will probably get some blowback from that statement.
But if you think I'm nuts, then you don't truly understood what I have written above.
Go back and read the Roll-Off section, then try it in a demo account.
That being said, you will make your life easier if you choose a high-probability countertrend turning point. Again, just pick one…support and resistance or RSI are good places to start.
Position Sizing
Start waaaay smaller than you think is safe. A good rule of thumb is to calculate what would happen if your position was down 1,500 pips.
This could happen, so be prepared. Again, you will need to demo trade for some time so you can learn how to get out of these situations.
That said, I believe in having a 2:1 hedge, at most. If you are unsure about the direction of the market or you want to walk away from your trades for awhile, then it's better to have a 1:1 hedge.
Again, this is a personal preference, so do what works best for you.
Start with 1:1 and go from here.
The Worst Thing That Can Happen in Zen8 Hedging
Without a doubt, the worst thing that can happen to you in Zen8 hedging is being stuck with a large position that is down 500 pips, or more, on one side of your books.
I've been there and it SUCKS.
For example, if you have a large long position that is down 500 pips and you are flat on the short side, it will take much longer to Roll-Off enough profits on the short side to close out that 500 pip deficit.
You might think that the worst thing that can happen is the market moves violently, like it did during Francogeddon. That is certainly a risk, but if you are properly hedged, that shouldn't affect you.
The losing position will be offset by the winning position.
Download the Free Zen8 Forex Hedging Strategy PDF
To get more details on my Zen8 hedging method, click the button below to download my free Forex Hedging Strategy PDF. In this PDF guide, you will learn things like:
- My favorite pair to trade with Zen8
- What to do when I picked the wrong market direction
- How to take advantage of interest rollover
- And more!
Why I Stopped Hedging (and Why I Started Up Again)
The reason that I stopped hedging, and started up again, can be summed up in one word: mindset.
Our minds are funny things.
They can cause us to do things that move us away from things that we want and towards things that bring us pain.
Someone in my mastermind group pointed out that some people have a subconscious need to solve problems. Once they solve a problem, they get bored and look for another problem to tackle.
I immediately identified with that statement and realized what I was doing.
So if you have some success with this hedging method, but you start to have some doubts, then ask yourself why you are going to quit something that's working.
Here are the reasons I told myself that I should stop trading Zen8:
It's Too Stressful
My stress was self-imposed. I was micro-managing my positions and was always anxious about them. Once I adopted more of a swing trading mindset, hedging became easier and more fun.
It's Not a “Real” Trading Strategy
No stop losses, are you crazy?
Conventional trading wisdom says that you always need a stop loss. That is true for the most part, but I've learned that there are exceptions to every rule.
This is one of those exceptions. If you are properly hedged, then stop losses actually aren't necessary.
The Gains Aren't Worth It
Another reason that I stopped trading Zen8 is because it's a low return trading strategy. I was stuck between trying to learn how to build a small account and how to build a track record to attract investors.
Depending on what day of the week it was, I would lean one way or the other. That was a poverty mindset.
Why not do both?! That's an abundance mindset.
Why I Started Up Again
Fast forward to 2017 and I went to the Truth About FX Conference in London. One of the speakers was Gonçalo Moreira, the head trader at FXStreet.
You can watch his trades in real-time here.
His shared his Coastline Trading Strategy in his presentation and it was very similar to the way that I had been hedging.
He started trading this way because he noticed that a lot traders who won online trading contests were hedgers. That's when everything clicked for me.
Gonçalo's track record and research finally gave me the validation that I needed to continue trading my Zen8 method. It's weird…even if we see a method working, sometimes we need validation from someone else to start trading it.
Anyway, I'm grateful to Gonçalo for sharing his method. I also encourage you to keep learning new things and attend trading events.
Here are my results since I started trading it again.
Remember that with my hedging style, I'll never have a huge winning month. But I'm going for consistent profits of 0.5% to 2% per month.
Conclusion
A word of warning about this method…
It can be very easy to start seeing profits right away. This can lead to Acute Cranium Enlargement (ACE) and taking oversized positions.
If that happens, then you are in for an education in digging yourself out of a deep hole. It's possible, but it's also very painful.
Trade conservatively and Zen8 can be a lot of fun.
Get cocky and it can become a total grind and you might feel like poking your eyes out with a rusty nail.
So start small in a demo account and figure out what works best for you.
Happy Hedging!
If you want to learn more about how to hedge in Forex, join my Zen8 Forex Hedging Program.
Hi Huhh,
Do you teach one on one?
Thanks,
Lawrence
Hi Lawrence,
Not right now.
Hi, great article you have here! I have read what you’ve presented quite a number of times and I can’t help but get stuck on one minor detail. Let’s say I enter a buy and sell on EURUSD for 1.00 Lot on each side. In addition, let’s set my target interval to 50 pips. Once price goes up 50 pips, my long is now +$500.00 and my short is now -$500.00. I understand that at this point, I would use the Roll-Off; Close 100% of my long for +$500.00 and close out -$250.00 of my loser because it is 50% of my gains. This would mean I have banked a total of +$250.00 with a -$250.00 “float” on the short side.
My position size on the short side is now 0.50 Lots. If my understanding is correct, I would also open a new hedge equal (for a 1:1) to the remaining short. At the 50-pip mark, I should have 0.50 Lots on the buy side and 0.50 Lots on the sell side. Now, this is where I’ve noticed things getting tricky… Let’s say price goes up another 50 pips (100-pip mark). Now my buy side is in profit by +$250.00 ($5.00 x 50 pips) and my sell side is down by -$500.00 ($5.00 x -100 pips). At this point, I close out 100% of my buy for a profit of +$250.00 and IDEALLY, I would close out -$125.00 of loss on my sell side order (since it is half of my +$250.00 profit). In this case, the -$125.00 is only 25% of the losing sell side order (the sell side order is now 0.50 Lots x -100 pips = -$500.00). As a result, my “float” on the sell side would now be -$375.00.
At this rate, it seems that my negative “float” will only continue to get larger. What I mean by this is that although the Lot size is decreasing on both sides, the amount of pips price is moving against sell/losing side is increasing and as such, “getting flat” seems impossible because the diminishing returns on the winning side cannot keep up…UNLESS you open unhedged orders or another hedge series to compensate for or balance out the negative float.
Buy/Winning Side: Sell/Losing Side: Profit: Float:
(1.000 Lots) x (+ 50 pips) = +$500.00 (1.000 Lots) x (- 50 pips) = -$500.00 ($250.00) (-$250.00)
(0.500 Lots) x (+ 50 pips) = +$250.00 (0.500 Lots) x (- 100 pips) = -$500.00 ($125.00) (-$375.00)
(0.375 Lots) x (+ 50 pips) = +$187.50 (0.375 Lots) x (- 150 pips) = -$562.50 ($ 93.75) (-$468.75)
As you can see, it doesn’t seem sustainable. However, I hope that my math and understanding is grossly incorrect because it seems as though the more Roll-Offs that you do, the larger your negative “float” becomes.
Question 1: When you mention getting flat, is that a reference to zeroing out your negative float or having no trade positions open for the hedge series?
Question 2: If the losing position is becoming progressively larger (in terms of dollars accrued by negative float) due to the number of pips being added with each Roll-Off, even if you closed out the 100% equivalent of loss from the losing side to match the profit made on the winning side, there will still be diminishing returns on the winning/buy side. If that is the case, how can one get flat without opening another hedge series or other un-hedged trades? Or would un-hedged trades be the answer to this problem?
Hey Keith,
Yes, good questions.
First of all, the best thing to do is open a demo account and try this out for yourself, if you haven’t already. It’s hard to conceptualize this without actually doing it.
Second, the 1:1 hedge and the 50% Roll-Off is just a starting point. Remember that you can hedge and Roll-Off 100%, 50%, or whatever you feel is appropriate. A lot of people try to trade this mechanically according to the start point example above, but that will never work.
You also have to understand price action or use some sort of trading strategy that gives you a frame of reference on when to buy and sell.
For example, if you are at a strong resistance level on the daily chart and you have a naked short position, it’s probably not a good idea to take a 100% hedge on the long side. It’s probably better to take a 25% hedge and wait to see what price will do at the resistance level. If it breaks to the long side and holds, then you might want to add another 75% to the hedge. If it bounces and heads down, then you won’t be stuck with a bunch of losing longs and it will be easier to offset that with your winning shorts.
1. Getting flat means having no positions on both the long and short sides.
2. The key here is to understand your net position on both sides, and your worst case scenario. So if your max size on each side is 1,000 nano lots, you should be willing to take as many trades as necessary within that limit and not think of it as having to always do a 100% hedge. Sometimes there’s an opportunity to take profit of 10 pips on a small position. Sometimes you want to hold a bigger position for a bit, until you see a good place to trade.
Finally, remember that if you can accrue a net position that pays positive interest, then holding a losing position isn’t necessarily a bad thing, as long as you are hedged at a good spot and are actively looking for ways to get flat. If your positive interest position goes into the money far enough, you can even consider removing the hedge and using a straight stop loss.
Hey,
Awesome article but I’m still trying to be my head around heading… Let me give you a quick example and see if you can help me to understand better your approach:
1st Open 2 positions (Long and Short)
2nd Long position is now USD 500 and short position – USD 500. Close your long position and reduce your short position by half. Net profit of USD 250 and floating loss of -USD 250.
3rd Open a long position to hedge your short position.
Let’s say now that the market is a Bull market, my long position would go +USD 300 but my short position -USD 300… Since I was already carrying a – USD 250 on my short now I have – USD 550 floating loss.
What I don’t understand is… if you keep going with that approach you might realize some profits but you will always have a floating loss.
Am I missing something hear?
Hey Marcelo,
It’s very difficult to get the concept by writing/reading about it. I would highly suggest using a demo account or backtesting software to give it a try, without risking real money.
Hedging requires you to carry a losing position, that’s just how it works. There are no free lunches in trading. You are exchanging the risk of taking a hard stop loss for the risk of carrying a net loss.
However, the amount of time that you carry that position will depend on how diligent you are in trimming your losing positions and how good you are with building net interest bearing positions.
Let’s break down your example:
1. Long 10K units of EURUSD
Short 10K units of EURUSD
2. Market moves 500 pips in favor of the long. Result:
Long 10K units @ +$500
Short 10K units @ -$500
3. Take profit on the long and Roll-Off part of short. Result:
Long 0 units @ $0
Short 5K units @ -$250
Banked profit: +$250
4. Hedge 100% again with a long and price goes 600 pips against you. Result:
Long 5K units @ +$300
Short 5K units @ -$550
5. Roll-Off long again. Result:
Long 0 units @ $0
Short 2.5K units @ -$400
Banked profit: +$500
So there are a few points that you might be missing:
1. You probably wouldn’t let the trade go 600 pips against you before starting to work down the short side. That’s a lot of pips in the EURUSD. You would probably start working off your loss much earlier.
2. You can always add new positions to either side to start working down the losing short position. The market will ebb and flow and you could even take new short positions and roll those profits off your losing short position.
3. You just reduced your short exposure from 10K units to 2.5K. That’s a 75% reduction, which is huge, and makes it much easier to get to flat within the next few trades.
4. You could also choose to take money from your banked profits to reduce your floating loss even more.
Remember that this isn’t a cut-and-dry method, so there aren’t specific rules. It’s way more art than science. Again, practice is the best way to figure out what works best for you.
Hope that helps.
How did you bank 400 in number 5 example? If in 4 you had 300$ profit and 550$ loss you closed 300$ profit and Closed 150$ which is half of 300$. Net is -400$.
Yes, that’s a typo and it’s been changed. Thanks the for the heads up.
It should be +$500 banked and -$400 floating loss.
#3: +$250
#4: +$150
Total: $500
Hi Hugh, one issue I always had when trading future spreads was getting legged on the entry / exit. It tended to happen on the busier days but was sooo annoying. We used an autospreader which made it a little easier but still
Do you find yourself getting legged much in FX?
Hi Sam,
I’ve never had issues getting legged in/out of trades in FX.
I’m not sure if you’ve traded this strategy using oanda. Do you know that they don’t have partial closing on a hedge account over there?
I trade with two accounts, one long and one short because we can’t hedge in the US. Still working fine for me. Not sure what you mean, did you watch the video?
OANDA have their own world TBH, like the way they do swap and partial closing of trades :p For a non-hedge account, if you want to partial close, you issue another transaction. Say you have 1,000 units long, you sell 500 units. For a hedge account, this won’t work.
OK, I did some research on this and it is possible to use my strategy with a non-US Oanda account. You are probably looking at the tab that gives the total position, that’s why your trades are all mashed together. Can you double check and let me know?
Hi,
Thanks for this nice article, I’m doing inverse hedging but have to time the market entry! Like the concept of trade anytime so would like to know more but can’t download pdf, it says internal server error.
Thanks
Sorry for the inconvenience, not sure what the issue was. I just tested it and it’s working fine now.