to Stop or to Hedge

Originally posted by Trae ↑

Hi Mick

Whilst your question is around profits/risk, the question may be better focused on cost and reward.

To Cost:

The costs would be different to the tune of the transaction cost.

Your provider will determine how the transaction cost is calculated.
Costs will either be passed on as execution costs (brokerage + friction + slippage) [typical of a DMA or fully hedged provider] or via the quoted spread [typically in the case of a market maker].

Taking the market maker as an example, if you buy at the bottom you pay the spread & when you sell at the top you pay the spread. When you open a short at the top of the range you pay the spread again and you pay it again when you close the short.
Open/Close 10 long/short positions in a day and you will pay the spread 20x!

If you take the approach of getting set then unwinding a position you pay the spread twice on open (once establishing the long, once on the short then once on close).
When you open a long:short in short succession it doesn't take a lot of skill to open the short 2x spread above the long (You could do this with high probability using 2 conditional orders while you sleep).
If you agree you can reduce the expectancy of opening cost to near zero.

This means a 50% discount on intraday transaction costs.

To Reward:
The reward would be different to the tune of your ability to subsequently pick a turning point.

To paint a picture for the discressional trader perspective.
You place a buy and set a stop.
It goes wrong and hits your stop.
Your stop was set on a risk reward basis.
The mental conflict kicks in because the trade that just got stopped was based on your solid view of what you saw eventuating - unfortunately it didn't.
The conundrum is when you ask yourself, would I go long here, the answer is yes. I though it was cheap before & it's event cheaper now. Zooming out daily/weekly/monthly my view looks solid.
You place another buy. The situation repeats.. ( a fractal conundrum..)
With each cycle your book is decreasing in value and your getting closer to blowing up.

Had you substituted your stop for a conditional hedge:
Your cost would have been no worse off than 1x spread from the initial stop out scenario.
You would have been taken out of the market however your account balance would not have been reduced - You would not have compounded down.

How you handled the situation subsequently would be dependent on your strategy but for mine, the opportunity to wait for the market to turn puts the odds in your favour of turning that loss back into a high probability directional in your favour.
I.e. Had you stopped out that money is gone.
Had you hedged, you retained the amount of money in your account and would have been handed the time to take a bet in the opposite direction when you decide the market says the probabilities are for a move to the downside (a second chance for the cost of the spread).

I hope this makes sense

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I have a friend who used your kind of approach with a demo account. He converted $10k into $50k in a few months. Then he moved to a real account and got wiped out quickly.

Obviously, your approach works well in a ranging market. As you say, it's frustrating for price to hit your stop at a point where a good entry has become a great entry. And it's great to be taking profits every time you close a position. In a way, you are using the CFD provider's strategy against them.

But it does get complicated when price starts trending, or if it moves say 30% out of the trading range. What do you do then? Your suggestion is something to do with fractals and standard deviation. At that point, a simple strategy becomes complicated. Then another complicated strategy will probably work just as well as yours.

One thing I am curious about is what happens if there's a giant move like when the Swiss govt changed its policy and the USD/CHF fell 25% in 20 minutes? People lost their houses over that. So I switched to always using guaranteed stops. In such a situation, would your conditional order be triggered? The provider would call that a Force Majeure event, so they would suspend trading and ask you to phone to place a deal, then everyone is phoning so you can't get through in time.

One solution might be to have very wide guaranteed stops at a point where you reckon it must have started trending to hit them. But normally they don't let you have guaranteed stops for trades going in opposite directions. I suppose you could use two different providers simultaneously. Ah, but then it has become complicated again.