ABC Proto Hedging strategy
To ‘hedge’ means to buy and sell two distinct instruments at the same time or within a short period. This may be accomplished in different markets.
In most industries, in order to limit the risk of loss, you should buy insurance. This applies to the financial markets as well, but in order to avoid the insurance fees, a hedging strategy has been developed. One of the first examples of active hedging occurred in 19th-century agricultural futures markets. They were designed to protect traders from potential losses due to pricing fluctuations of agricultural commodities.
How the Strategy works
ABC's proto Hedging strategy was designed to limit risk for investors by choosing two positively correlated pairs like BTC/USD and ETH/USD or LINK/USD and UNI/USD and take opposite directions on both. Hedging is meant to eliminate the risk of loss during times of uncertainty — it does a pretty good job of that.
But safety can’t be a trader’s only concern, otherwise, it would be safest to not trade at all. That’s why we use technical and fundamental analysis to make the hedging strategy profitable, not just safe. This is where the analytical ability that will make you a profit while you take opposite positions on correlated pairs will come into play. When deciding to hedge, the ABC proto hedging employs analysis to spot two correlated pairs that will not act exactly in the same way to the upside or downside movement.
Example:
An example is the hedging strategy between the correlating commodity currencies AUD and NZD. On the weekly charts of these two currencies against the USD above we can see clearly that AUD/USD has been in a strong downtrend of about 2,000 pips and the retrace was worth only about 800 pips. This occurred while NZD/USD was on an uptrend, with a bigger move up than the previous decline.
After the retrace on the weekly and the daily charts from 4–5 weeks previous, the uptrend was about to start its next leg up. The best option is to take a long on NZD. But to be safe, in the case of failure to continue the uptrend, a short on AUD is a more suitable play.
If the pairs were to fall, the AUD which we sold is to fall harder since it’s more vulnerable to downside pressure than the NZD which we bought. The loss on the NZD was likely to be smaller than the gain on the AUD, ensuring a profit even if we were wrong about the uptrend. In the event we were correct, the NZD long was to create bigger gains than what we lost on the AUD short, guaranteeing a profit.
After entry at the beginning of June in the same year, NZD/USD saw a 400 pip gain. Conversely, the short in AUD/USD realized only a 200 pip gain for the same time period back then. That leaves us with a 200 pip profit. When hedging forex, we have to compensate the less volatile pair with a bigger size. NZD moves are about 20% smaller than AUD, so when entering the hedge the NZD trade size would be 20% bigger, therefore making the 200 pip profit a 2,400 USD profit.
Management and Analysis:
Cedefihedge now manages this strategy, which has a total AUM of $77,009. As of the writing of this article, the strategy has achieved a lifetime return of 78% from the time of its creation, and it is open to both retail and accredited investors on Cedefihedge.
