Forex Calendar

Economic Calendar >> Add to your site


Sunday, November 1, 2009

Correlation and Hedging

Anyways I would like to make a post about hedging and correlation. Two trading terminologies that confuse a lot of traders. The relationship of these terminologies to our system.

*Correlation and Hedging*

Correlation is a determined relationship between two or more pairs which could either be negative or positive. Negative correlation is the relationship between two pairs wherein one goes the opposite direction of the other pair. Example of these is the EURUSD and USDCHF. The measured difference of negative moves between the two is the percentage of negative correlation. Positive correlation is the opposite. Example of these is the GBPUSD and EURUSD. This is a relationship between two pairs that both will be moving in the same direction. The difference of the rate of moves is called the percentage of positive correlation.

Hedging a trading strategy where you buy one pair and sell another pair if they are positively correlated or buying one pair and also buying another pair that are negatively correlated. Opps sounds complicated. Ok here is an example; since we now established that EU and UC are negatively correlated, then buying EU and buying UC will have a semblance of hedging. Or the selling of GU and the buying of EU will also have a semblance of hedging.

However if you want a perfect hedge, then you sell EU and buy EU, this will never get you anywhere except losing for the spread and swap fee. This practice however is now disallowed by NFA. It falls under the category of no hedging. Well here is another hedging that will not fall under the disallowed strategy: Buy EU, Buy UJ and Sell EJ or Sell EU, Sell UJ and Buy EJ. If you calculate properly the traded lot then you will have a perfect hedge that will not get you anywhere as well.

*Hedging and the Basket Trading System (BTS)*

The 14 pairs that we are trading in the basket and the direction they are being traded are in hedge strategically. We could calculate the proper trading lot for each pair if we need it to fall under the category of perfect hedge. But what is the point? The lot size was intentionally left as 1 unit in order to create an imbalance. With this imbalance we allowed the pairs to swing either in the positive or negative portion thus creating a synthetic trend that will guide us in our trading.

With this explanation I hope that clears some misunderstanding of what we are doing with the BTS.

Sources Quote From Julius (trade101)

No comments: