Hello
This is just an idea I have been toying around with for some time, and would like any comments. I am aware that it isn't a new concept, but im just experimenting with non standard transactions.
So here goes :
EURUSD and USDCHF possess a negative significance of -97.7 using daily closes for n = 50.
If I remember correctly, -100 is perfect negative correlation, therefore , it would be safe to presume that if EURUSD is bull, USDCHF is bearish, and vice versa.
Overlaying daily line price chart of EURUSD over USDCHF (easy to perform with FXCM's platform ) will easily demone that EURUSD USDCHF move in opposite directions.
But if we were to take a directional commerce, it would be sensible (and risky) to presume that when EURUSD USDCHF are converging, moving long with one pair while moving short on another could be profitable. In case we chose the incorrect pair to go long and the incorrect pair to go short, a stoploss in both pairs would be required.
Again, when the pairs had been divergent, it would be sensible to presume that a convergence could at some point happen, hence going short on one pair, and long on another.
However, this theory has one defect: when the pairs don't converge when away, we lose money. Same applies for the contrary, if convergent we cannot know for certain when they will diverge (although technical analysis on both pairs would help).
So here is the hedging.
What if we placed 2 brief orders. Assume pairs are divergent, and sooner or later, they would meet at their own axis. If we go short on both pairs, it would not be possible for both to go long, and go short. So essentially we are gambling the pairs I will converge, but we are hedging our reduction from the pair which goes long, in order to meet with the pair which has gone short.
Creating sense?
Now this is the tricky part.
EURUSD and USDCHF don't have exactly the same price, don't move the same distance, meaning that they have different voltility.
So we would have to ditch the correlated pairs, but suppose that we'll be making a small profit from the pair that's most volatile, while hedging with the pair which is significantly less volatile. A quantitative formula might help here, but I am clueless on how this might be calculated.
Therefore, by empirical information (ATR indior), I understood that EURUSD (now at 1.4679) is much more volatile than USDCHF (now at 1.0301) and because USD has been long oversold, and due to various technical signs I think EURUSD is going to fall, which again implies that USDCHF increases, I chose to go brief EURUSD and at exactly the same time go long USDCHF. Their negatively correlated movement implies that their movements will cancel eachother out, leaving room for a small profit from EURUSD if it moves quicker than USDCHF. Of course that small profit can be amplified by employing large lot sizes.
And as a fail secure, a generous Stoploss might be employed on both pairs, simply to be sure.
Thus, ideas, thoughts and opinions?
This is only hypothetical, it's not my idea (correlation hedging with regards to forex have been around for long), but I am wiling to test it and fine tune it to see whether a small profit could be made.
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