I am a part of the team which is responsible for management and hedging of commodities exposures. Some say corporates are good only in following advice from banks or brokerages. I do agree corporates do not have market insight of a bank. But here is a problem. It is not bank or broker or a hedge fund that has biggest risk that markets will go against them. These guys always have an option to do nothing and wait for a better trading opportunity where as we don't. We have to continue to purchase commodities, spend currencies for daily business. Such company is always exposed to changes to market price even if it decides not to hedge. In fact my company has probably one of the biggest short commodities portfolio in the world. Managing such risk effectively is a challenge. It is like being between a rock and a hard place. You get your behind kicked all the time be senior management, whether it was a missed opportunity to hedge or hedge that turned to be out of the money. Critics will say if you lost money on your hedge then you probably bought it cheaper on physical market. let's face it, nobody wants to loose money, full-stop.

So I do not have an option to do nothing as I am always in the position (short in this case). I think people like me have higher motivation to earn positive return on their portfolio then other players. In fact my intention is to bring hedging to a performance benchmark of proprietary trading.

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Wednesday, May 19, 2010

Hedging should go further then hedging

To my mind one should approach every hedging strategy like it is your own money. What is the entry point, stop loss, take profit, time frame of the trade and the most importantly risk/reward ratio. What is a risk reward ratio? The answer lies in the question: how much you are willing to risk for a certain profit. Again, forget about physical side of the market and this absurd idea that if you loose on your hedge then you win on your physical exposure. This is a loss in the end...

Traders normally prefer to risk $1 in order to have $3 of potential gains. Mathematics is simple here, if you have equal chances to of winning and loosing, over the long term you will be earning money. But my experience shows, that 1 to 3 risk reward ratio is not enough, you need at least 1 to 5+ to be profitable by the end of the year, but this depends on the trading style.

Does fundamental research provides you with the plan for a trade? Clearly no. More work is required. So hedging strategy becomes a trading strategy. (and for the people that are aware of this... SCREW HEDGE ACCOUNTING!)

Everyone knows that trend is your friend until it ends. So the question is how you define a trend. I personally like to identify trends visually with the help of moving averages. Despite the latter are a lagging indicators, they serve as good support and resistance levels. Let's have a look at the world through moving averages:



Technically I am not buying this market until at least half of it goes green (price goes above moving averages). Before that I will ignore call on fundamentals getting better.. Trending and not necessarily fundamentally strong/weak markets are the ones we make money in. more tech analysis to follow soon.
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