Hedging 101 (protecting profits or pause a trade)

Hedging occurs when a transaction is entered to reduce exposure to a prior trade turning against you and eliminating profits or increasing losses. Hedging is done to decrease the risks and hold a position until the markets begin to move in the original trade’s favored direction.

Just like finding entries, it is even more important finding exits.

It is especially important in the case a Day-trade turns into a swing trade.

Swing trades usually carry much smaller size because the stop-levels are much wider.
Using the same size on a much wider stop would massively increase the risk of the trade.

As seen in the picture below, the blue line is a support from a larger time frame, so the possibility that price may bounce there is very high. There is a chance that the bounce may completely eliminate the gains made.

Taking profits out at this point would be a wise choice.

However, we expect the price to fall even more and turn this day-trade into a longer lasting Swing-trade.

We could then:

  • Take part of the profits out to meet the size requirement of having a much wider stop-loss.
  • Hedge at the possible turning point, ensuring the gains we have made on the trade stay with us, even if the price moves against us.

What can we do next?

  1. Wait for the breakout.
  2. Wait for the retest of the support as resistance.
  3. Once the downside is confirmed, close the long position at small profit or loss.
  4. The original trade can continue with the same size & risk.
  • The loss of the Hedge position is paid already with the gain of the original trade.
  • Cost of doing this is spread + Swap (if the continuation takes overnight)

What if there is no breakout?

  • Then you just close both trades. Realising the original profits (minus spread & swap of the hedge trade)
  • Losses generated by either original or hedge trade are not relevant as they cancel each other out.

The loss of one position will be the gain of the other.