Alex’s last day today and I think he’s done very very well, bravissimo.
They think it’s all over….
Day 5: Be aware, be prepared: trading big events – hedging techniques;
Every time you choose to trade big news, important data (i.e. NFPs), Central Bank events, you must be aware and prepared. Period. You can also choose to be sitting on a fence and wait for a clearer vision of the market behavior before pulling the trigger (safer!). But now you really want to trade. Well. Read everything you can about the event, then confront it with price action. Don’t take anything for granted.
In example let’s have a look on RBA central bank decisions. RBA is following a cutting rate cycle since 2012. But I have seen every sort of reaction to rate cuts or no cuts, because there are also Central Bank statements which offer an outlook (hawkish or dovish) on the Australian economy, giving hints for the Central Bank action in the future. Was AUD/USD already falling in the last few days? Market could have priced in a rate cut yet, and jump like a grasshopper after a hawkish statement!
To cut a long story short I never know how the market will react. So I like to cover my trade with an opposite trade by choosing a feasible pair containing the same currency, like EUR/AUD. How much should I hedge? It’s a very simple calculation: take your scalping setup and confront the ATR of the main pair against the ATR of the hedge pair during past similar events (i.e. RBA rate decisions). In the case of AUD/USD you can see that ATR is roughly half of EUR/AUD, in other words you need 1 unit of EUR/AUD to hedge 2 units of AUD/USD. If you want to use AUD/NZD as the hedge pair you’ll find that the two ATRs are roughly similar, maybe AUD/USD a little higher, so 1 unit of AUD/NZD hedges almost 1 unit of AUD/USD. Hedging will never be perfect though, but it’s better than nothing.
The tricky thing starts when you set the close of the hedging position, which could be losing heavily, so you have to choose how many pips you will lose: this is the cost you have to pay for hedging. You start a trade like this already knowing that you will lose money! There are no free lunches on Forex though. I’ll tell you that while trading FOMC (or NFPs) I use a similar setup. On September 2013 FOMC I lost 50 pips on AUS/USD and won 190 pips on NZD/USD. In this case the hedging factor between the two pairs is 1:1, because they usually react against USD in the same way. Pay attention that I was mildly USD bearish then, so I chose NZD/USD for long and AUD/USD for short, because NZD was stronger than AUD as my AUD/NZD chart suggested. It couldn’t never go smoothly like then again, but if the market doesn’t know what to do you can still close both the opposite positions and win/lose just a little on a hell of an event, resulting in a mass carnage.
I strongly suggest to practice this difficult technique on demo accounts before trying it for real! You should develop some confidence because, if not, you will end with a big loss. Experience is everything in trading.
That’s all. Happy trading to everybody!
