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Trading: Primarily Energy but also a little Equities, Fixed Income, Metals and Crypto.
Frequency: Many times daily
Duration: Never
Posts: 5,049 since Dec 2013
Thanks Given: 4,388
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I stopped following this conversation as it was going nowhere but here I am again. Buying and Selling the same quantity of the instrument is not hedging you are flat. How somebody can argue that this helps with the psychological aspect is amazing to me. What is the psychology of being flat?
Buying and selling different contracts (aka the crude example) at different times, could be considered to be a hedge. As Kevin points out you have converted your outright price risk to spread risk.
Side question... what happens if you now do another spread to hedge that spread? ie if you had bought month 1 and sold month 2, what happens if you now sell month 2 and buy month 3 to hedge that position?.
The discussions of arbitrage between different months is very commodity specific. For equities like @ES it's a function of cost of carry/interest rates vs dividends, for currencies like @6E it's a function of US vs European interest rates. For precious metals like @GC it's a function of storage costs and cost of carry/interest rates. When you get to commodities like Crude @CL (or NatGas @NG) things get a lot more interesting as storage is a) limited and b) not generally available even if you want it. Also unlike commodities like Gold @GC which are in contango primarily due to carry costs, @CL is backwardated. No amount of storage is going to allow you to arbitrage a backwardated market! People who write and read textbooks, and don't trade, explain this as being due to the convenience yield! For people still trying to decide whether being both long and short is flat or hedged, the concept of arbitrage is probably a little advanced!
I've used CFD hedging quite a lot in the past. It's really helpful when you're in a trade but the trade moves against you more than expected while your premise behind the trade is still accurate, and you don't want to close out the trade and take a loss. I've only ever used it in ranges, and it is quite difficult to do well as it adds another layer of complexity to trade management. As far as costs go, it doesn't cost any extra if you stick to day trading only. Whether you are flat or not, I would say not, as both position were not opened at the same price and flat really means - not having any open positions at all - maybe I'm wrong.
Let's say Monday morning you go long. Price goes down, so on Tuesday morning you decide to "hedge" and go short. So Tuesday afternoon you are long and short.
What do you think your NET position is on Tuesday afternoon?
Now Thursday, morning, you decide to close the long and the short. You are now out of the market completely. So, you made 2 round trip trades - a long entry and exit, and a short entry and exit.
Instead of your approach, Tuesday morning I exit my long, so I am flat Tuesday afternoon thru Thursday. I stay flat. I made 1 round trip trade.
Not counting for overnight interest/rollover costs (which would be more for you), we have the same gross P/L. And net P/L, I did better than you, as I took 1 trade, but you too 2.
Do you agree with my example?
So, if you follow my example, what benefit did you actually get from going long and short?
Trading: Primarily Energy but also a little Equities, Fixed Income, Metals and Crypto.
Frequency: Many times daily
Duration: Never
Posts: 5,049 since Dec 2013
Thanks Given: 4,388
Thanks Received: 10,207
It's more than that. It shows a lack of understanding of risk.
I suspect it's a psychology 'thing'. Nobody ever talks about 'hedging' winners, it's always losers. I think it's a way of avoiding acknowledging it was a losing trade because it's not closed. Then the second new trade, is now part of the original first trade and if you get the combined back to breakeven then you tell yourself you had 1 winner rather than 1 winner and 1 loser. Mind games!
