Hedging Global Macro Trading Tutorial

Hedging means hedging and there are many different strategies. My observation is that more than 90 percent of hedge funds, investment banks and institutional investors trade “Global Macro”. If you listen to professional traders and hedge fund managers, you will hear statements like: “We have a global macro approach, we are market directional and use also relative value arbitrage and invest in distressed debt. …and invest in distressed debt.

Hedging in foreign exchange trading

Below I have a EUR/USD chart on a 15 minute basis and have plotted an intraday sideways phase.

Now let’s just assume that at 1.1290 we take a fully hedged position of EUR 1m long and short, which means that we have the spread plus commissions on the clock, say 0.8 pips, opening the overall position with a loss of USD 80. Now the market is moving up and so our long leg is in profit and our short leg is in loss.

We also assume that we at least have the experience and basically follow the strategy “we buy @ support and sell @ resistance” and that we drop our long leg close to the moving average (magenta colors), resulting in +28 pips. So we have a net short exposure of 1 million EUR and in fact the price corrects and we close our short leg at 1.1305 with a loss of -15 pips and we are flat. As a result we have a net result of 11.5 to 12 pips, which at 1m EUR = 1150-1200 USD.

This example is just to illustrate how I personally dealt with hedging and I didn’t act like that, but had a much more complex strategy that I followed. However, I think that anyone with a little bit of experience will understand how hedge funds etc. operate, because they usually have exposure on both sides and throw off parts of their positions in certain zones and they usually trade successfully.

Finally on this forex topic, it should be mentioned that with good brokers you only have to deposit your “net exposure” as a margin. When opening a position of EUR 1 million long and a leverage of 200, the account is debited with EUR 5,000. As soon as you open the short position, you get the margin back because you have just provided the market with liquidity (brokers like that = no risk for them and guaranteed commissions).

Trading breakouts in the stock market

Now to what I have traded since March 2016 and my current position:

I’ve gone long on several stocks and, thank God, almost all at a profit.

These are classic breakouts, whereby I took profits on most shares at least once and my SL, according to my rules, was above entry at some point.

With DIS, GILD and MCK I was able to take profits twice, but I am not satisfied with my own trade management with EBAY and MU. With EBAY I finally broke even despite one profit-taking and three breakout attempts and with MU I suffered a net loss despite profit-taking. Of course I am learning from this and will try to do better in my next “attack”.

Interim conclusion 1:
Considering these equity positions alone, I had a long net exposure in equities = a net long position in the equity markets.

Hedging for the poor in the stock market

Independent of my equity positions, I started to build up short positions in the SPY on 17.03.2016, because, as mentioned at the beginning, I am trading two different strategies. Below is the chart of the SPY where I marked my short entries with blue ellipses and my partial profit-taking with red ellipses.

I am a “zone trader” in SPY and am interested in support and resistance. This trade turned out to be a “hedge trade for the poor” as I have been both stock long and index short in the meantime. At times I had “net exposure” long, currently I am not short.

My average price in SPY is 206.74 so I am currently trading at a book profit of +2 USD in SPY. I have made profits three times and the nice thing about this trade is that my shares have made profits in both long and SPY short trades.

At the moment I only have one long stock position, WFM, because all the others have been stopped, which is ok as the market is very unsettled.

Interim conclusion 2:
Hedging is not the holy grail, it’s a hedge, but it can lead to losses and gains on both sides.
There are very many different approaches to hedging that can be taken. EUR/USD long = USD short and at the same time AUD/USD short = USD long can lead to profits with reasonable management and can be considered.

The mental component should not be ignored and underestimated: I go long in stocks and I want the market to go up. On the other hand, I shorte the index, one should be able to deal with it mentally.

The Global Macro Approach

I looked forward to my video series like a little child and was sure that I would learn a lot through “the professional approach”. With the videos I got more than 30 different Excel spreadsheets plus 60 hours of core videos and more than 20 hours of bonus material. Each video is between 2-3 hours and so I started to plan my time for it. I started with the videos and can simply say I was overwhelmed by the information given and imagined it all much easier.

One thing to be said: Global Macro has nothing to do with chart technical analysis, but goes much, much deeper. These guys really look at the markets in depth and then form an opinion. They don’t do day trading (by the way, I’m not a friend of that either, for many reasons), but they go into a trade with a time horizon of at least 1-3 months. When I then arrived at video 4 (about 10 hours of complex formulas pulled in), the topic was to determine “the true ATR” of a currency pair. Now I myself use ATR = Average true range, but these guys use and determine this very, very differently than we do.

That was the moment when I said that I neither can nor want to do that. But I have learned once again and today I have a different, much greater respect for the Big Boys. It is indescribable how these people proceed. To give you a taste, I’m attaching some screenshots below so that everyone can make their own picture.

My conclusion Part I:

I’ll stick to hedging for the poor, if it comes up.
I’ll try to educate myself further by “watching” these video series over the next weeks and months, as my time allows. Education has never hurt.
I am very grateful that I have found my two strategies, which I trust absolutely and which I act on unconditionally.
I am learning every day.
I remain humble and can recommend to every trader to look into the subject of hedging and maybe find his own way.
As soon as I am flat with my trades, I will write a second part about it to report on the outcome.

Hedging for the poor – Part 2

What if we knew what the market would do in the next three to six months? Could we use this information to make a safe profit? Probably yes, because if you know the lottery numbers for next Wednesday, you should be able to tick them.

Unfortunately, we do not have this above information, but we can know one thing with a high degree of probability: namely the places where “price reactions” will occur. Can we use such information to our advantage? If you have sufficient market understanding, you should definitely try.

This chart tells us a lot and with the appropriate experience you know how to “read” such a chart in my opinion:

Most breakouts fail! This is just the way it is, most breakouts are failures, so I am currently trading this scenario on the short side.
If the breakout is successful, it is very likely that it will be a measured move. In fact, the past (and it is only from the past that we chart analysts derive our opinion) shows that successful breakouts occur as a measured move, i.e. a breakout from a trading range of 300 points (1800-2100) will probably go as high as 2400 points, see the following charts.

Not only do we know the most likely scenario in a case of a successful breakout, we also know how the market will move:

In the chart above, I have shown possible trend movements and corrections (retracements). It doesn’t matter how it happens, but there is a near certainty that there will be setbacks etc. in the upward movement. Also the probability is then quite high that 2400 is started at the end (whether 2350-2450 is actually no matter), we just know the direction.

Have a net position when hedging

In hedging you trade long and short and usually have a “net exposure”, which is a net position to a certain side (depending on the strategy, hedge funds sometimes also have a fully hedged portfolio = market neutral).

The following 6 stocks I am currently long:

  • Long position in Abbott Laboratories (ABT)
  • Long position in Allergan Plc. AGN.
  • Longposition in Illumina, Inc. ILMN.
  • Long position in Symantec Corporation (SYMC)
  • Long position in Whole Foods Market (WFM)
  • Long position in Apple shares (AAPL)

Here my intention and desire is very clear: I want each of these stocks to go up to $1 trillion, so I want the market to go up.

It is important to note that the index trade short is a swing trade and the stocks are position trades (from today’s perspective). If you do not know the difference, please google or Investopedia.

The blue ellipses show my short entries, the red ellipses show where I have already taken partial profits. From today’s point of view I have used 35% of my maximum short portfolio, so according to my trading plan I may shorten even more.

How does the future look like?

Nobody knows, but it is good to have a plan (plan the trade, trade the plan!).

If there is a breakout, I want to turn my swing trade SPY short into a scalp and my plan is to drop my short position as quickly as possible in profit or break even and turn it to long depending on the market situation.

If point 1 occurs, I want to trade my shares (I have 5 more shares as pending long orders in the market and hope that they will be triggered) with as much profit as possible and good trade management.
If point 1 occurs, but the breakout becomes a false breakout, it is very likely that my stock long positions will lose or break or trade like this. Then I hope to switch the swing trade in the SPY to position trade and make a profit. Why is that?

We do not know when what will happen, but when we see it happen, we know with a high probability how the market will move. So when “most breakouts fail”, we already know that it will happen in the price ranges:

  • 2020
  • 1950
  • 1800
  • 1760
  • 1650

will come to price reactions. What is clear for me right now? Should the price move in the direction of 1850-1800 or somewhere in between, I will try to place long in the index and hopefully in the stocks. Why?

Hedging is a challenge

I’m not a pure hedger, but hedging for the poor comes up for me now and then, and I like to challenge myself. The biggest challenge is to mentally deal with the fact that you are positioning yourself in both directions.

One more word about net exposure:

Let’s say my 6 stocks have a total trading position of $100,000 and let’s say my short position is $130,000, then I would have a “net exposure to the short side of $30,000”. So I would be net short.

When you trade like this, the net exposures change permanently. Let’s say my other stock pending orders are triggered and my long position increases to 200,000 USD and meanwhile I get a retracement where I close parts of my shorts, say 50,000 USD in profit, then I have a net long exposure of 120,000 (200-80).

Hedging for the poor is challenging but nice (from my point of view). It is more important to remember that we build the information like “measured move and market reaction” into our trading. After all, it is information that we all know weeks and months in advance and the “big boys” (institutional investors) pay attention to support & resistance and act there. These guys move the markets, not us.

Trading in the shadow of the Big Boys

I have called my blog derschattenmann.net , there I keep my trading journal (everyone should keep a journal about each of his trades, it increases discipline).

I chose this name at some point because I am fully convinced that we little “ants” do better in the shadow of the big “animals” and use techniques that are used by the big boys. For me, such an approach makes absolute sense.

Know how is important, but what’s the point without “How To”?

Often you will find some “guru” on the internet who promises you heaven. What is noticeable with such people is how much time and money they invest in marketing. Do these people even have time to trade? Or are they really so good that they can trade perfectly and train most of their time? Then why do they need my 20-500 euros a month? These questions are of a rhetorical nature, as most of these gurus can’t trade at all, they are just salesmen. They sell unsuspecting traders a dream that unfortunately does not exist. Others have traded once and notice how difficult it is to be consistently profitable. They have achieved a certain “fame” and are now taking unsuspecting people out because they can’t handle trading themselves. Trading is the fucking hardest job on Earth, at least for me!

I’m surviving it now in my 12th year, but any serious trader would also say: “I don’t know if I’ll still be at the start next year!

It is no shame to lose to Goldman Sachs, Deutsche Bank, JP Morgan etc. and be “kicked out” of the game. That’s the most realistic assumption we should make.

Should this happen to me one day, I have no problem with it (the emotional pain I will suffer, it will hurt me very much, but in the end I will cope). I will also have learned from this: a lot about the stock and money markets and how money works. And I think that is worth a lot.

If you love what you do and find the right approach, you will succeed; this is my firm belief, and it’s not only true for trading.

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