Friday, December 29, 2006

Hedged Trading

Another new idea. Seem to be a lot of these as I struggle to find a method that fits my psychology well and uses the model signals. Trade 1 NQ and 200 SPY (S&P500 ETF) in opposite directions. So say I am short 1 NQ then buy 200 SPY. This is equivalent to trading a position of $20 times the NDX and the opposite direction $20 times the SPX. Here is a chart of NDX/SPX:

Reasons to use SPY rather than a futures contract as the hedge:

1. I don't have enough money in my futures account to trade 5 NQ and 2 ES which is the correct ratio of futures contracts and I can trade the SPY part in my Ameritrade account.

2. The tax deduction on stocks is greater for a loss than on futures. As the hedge is expected to lose it makes sense to use stocks for this side of the position.

3. The leverage for stocks is lower and an apparent reduction in leverage is psychologically beneficial.

I've done some simulations and over the last year a fully levered (initial margin for NQ of $3750 and 50% margin for stocks) 1 NQ - 200 SPY position behaves pretty much the same as an unlevered 800 QQQQ position. The strongest gaining days are bigger in terms of percentage gain though - the worst losing days are about the same. So I am now experimenting with this idea live. Of course, if the trend is clear I can remove the hedge and even keep the hedge in the same direction and reverse the main position when the trend reverses. Not sure if I will just use the hedge when I am unclear on direction or all the time.

Last night I watched the movie "Pi". Really crazy movie. Anyway, I'm not like that guy though I am looking for patterns in the stockmarket and have studied the Talmud etc in the past :) One example - he didn't actually trade :P

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