Mathematical Model to Use Hedging Technique

There are several mathematical models that help in creating new Forex trading hedging strategies. I would like to explore a particular one using geometric progression. That is, any number can be written as an integer multiple of the other. Thus, 1,2,4,8, …, 2n is a progression.

Intelligent Traders never risk more than their equity can support. Then imagine that a trader starts buying and selling currencies at the same time having a $1,000 account with 100:1 leverage. If you buy 0.1 lots of XAU/USD with a profit of 100 pips then you get $100. However if you sell 0.1 lots of Gold your loss will be $100.

Suppose you suffered losses in the first case above and now you aim for a positive balance again. Just remember that every trade made represents one day. This is the first day. So far you used 0.1 lots XAU/USD.

Now imagine you make a second trade on the second day using the second number of our geometric progression: 2. So, you will buy 0.1 lot of Gold and at the same time sell 0.1 lot, totaling 0.2 lot.

But you still decided to add 0.1 lot as a fixed volume because your equity needs to be positive again.

The 0.1 lot added was a volume traded one day ago.

In the 2nd trade, we have 0.1 lot + [0.1 lot (long gold) + 0.1 lot (short gold)] > 0

0.1 lot > 0.1 lot (long gold) + 0.1 lot (short gold)

In 3rd trade, we have a new volume to negotiate. Let’s take 0.4 lot.

It was decided to buy 0.2 lot of gold and sell 0.2 lot of gold. But every hedging position generates a negative equity due spreads calculation. Therefore, we need to add the trading volume of the previous day + 0.4 lot (0.2 lot buying gold and 0.2 selling gold).Your balance will be positive again.

0.3 lot > [0.2 lot (long gold) + 0.2 lot (short gold)]

At the 4th trade, it was decided to buy and to sell 0.8 lot of Gold at the same time. Okay, so you negotiate the volume of the previous day plus 0.8 lot of XAU and at the end of the day the total volume was 1.5 lot (if you got 100 pips, your balance will have $ 1,500 in profit the same day).

1€ = 1 €                         (1° day)

1€ + 2€ = 3€                   (2° day)

1€ + 2€ + 4€ = 7€           (3° day)

1€ + 2€ + 4€ + 8€ =15€   (4° day)

Etc.

Note that we are doing a geometric progression each day in which the total volume corresponds to the volume of the previous day plus an integer multiple of two.

At the end of each trading day you have     lots for all n > 1. N represents the number of days.

Case 1:

You’re supposing to hedge orders. Profits would be a bit small but safer.

  • For the 1st day

0.1 lot (won) = $ 10

10USD represents 10 pips.

  • For the 2st day

0.1 lot + [0.1lot (won) + 0.1 lot (lost)] = $ 98

  • For the 3rd day

0.1 lot + [0.1 lot (won) + 0.1 lot (lost)] + [0.2 lot (won) + 0.2 lot (lost)] = $ 108

  • For the 4th day

0.1 lot + [0.1 lot (won) + 0.1 lot (lost)] + [0.2 lot (won) + 0.2 lot (lost)] + [0.4 lot (won) + 0.4 lot (lost)] = $ 216

In 10 days you would have done     in profit.

Case 2:

You are supposing to trade without hedging which represents a bigger risk although the compensation is higher too.

  • For the 1st day

0.1 lot (won) = $ 10

10USD represents 10 pips.

  • For the 2nd day

0.1 lot + [0.1 lot (won) + 0.1 lot (won)] = $ 30

  • For the 3rd day

0.1 lot + [0.1 lot (won) + 0.1 lot (won)] + [0.2 lot (won) + 0.2 lot (won)] = $ 70

  • For the 4th day

0.1 lot + [0.1 lot (won) + 0.1 lot (won)] + [0.2 lot (won) + 0.2 lot (won)] + [0.4 lot (won) + 0.4 lot (won)] = $ 150

In 10 days you may expect     which is a very good number.

Without Hedging, the general    turns into a higher profitability.

Look the Gold for example. Its fluctuations are so high that you can plan to trade with small hedging positions.

I guess you are able to get at least 50 pips on Gold.

Generally speaking, try to buy and sell currencies at the same time adding the volume traded the day before.

 

The article is written by Igor Titara and is participating in the Forex Article Contest. Good luck!

 

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