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.
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.
Table Of Contents
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.
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.
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
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.
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.
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
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.
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.
If you want to learn more about how to trade Zen8, the complete course is taught here.