March 2, 2013
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Trading Update 2/25 – 3/1: Rise of The Hedge/Delta Neutral Trader
The market continued it’s expanded moves this week and took no prisoners. The moves were very sharp and dramatic – basically straight up or down with little opportunity to safely enter a move once it started.
On Monday at the opening bell, the market basically collapsed and went into free fall mode. As I already had a long outstanding short position, that suited me fine as the market fell lower and lower in waterfall like fashion. At the end of the day, all my losses for the month were erased and I was looking forward to capitalizing on the rest of the week.
During this time I’m also trying to make use of hedge/delta trading where I take on both long and short positions, and that worked out favorably as well. Monday was a very good day.
Tuesday the market was relatively calm but still had some sizable swings. Trading today wasn’t nearly as good. Every trade was profitable, but I failed to maximize the returns due to bad analysis and planning on my part. I was expecting the market to move lower, but it drifted higher instead. As a result I missed closing some short positions for much larger gains. Another good day, but it could have been much better.
Wednesday I was expecting the market to head lower when it decided to surge higher with the same ferocity and strength it went down with on Monday. More bad planning by me in that I thought the market had a little more down side before reversing. Hedging saved the day as my losses were less severe due to counter positions, but I still gave a chunk of profit back to the market needlessly.
Thursday, I’m looking for a reversal back down, but the market continues to show strength. I’m applying my hedging strategy to try and work through my bad position, but my wonderful brain threw some more bad analysis on the pot, or I can chalk it up to still learning, since I messed up my hedge as the market reversed and I wound up buying too many contracts when I should have been selling. The market falls and at the end of the day I’m stuck with a hedge and a main position that are both negative, but losses are mitigated since they supplement each other.
Friday hits, and I’m back on track with the right analysis and planning. I anticipate the market rally, and start reducing my short positions as the market went lower in the morning. I wound up closing them too soon as the market went lower than I imagined, I could have closed them out with smaller losses.
The market looked weak enough to start getting me worried that I was wrong in my analysis again, but it soon started moving up, then took off higher with strength. Hedging was working well today to add additional profit to make up for most of the losses.
I had so many gain and loss trades that I didn’t know my actual net return for the week until I tallied all the numbers. Losing trades beat the winning ones for a net loss this week. If I had stopped trading on Tuesday, the week and month would have been positive, but where is the fun of being safe?
Is there a “YOLO” for traders? 
Checking my stats, this is my 3rd straight losing week, which hasn’t happened since July of 2011. That’s an amazing stat to me, since I remember the days when positive days/weeks were few and far between, and shows me how far I’ve progressed.
The good, better, and best news is this week taught me how to better use hedge or delta neutral trading which I’m realizing could be like adding rocket fuel to my returns.
My old style was pure directional trading. When I correctly determine the direction I can usually capitalize well on the returns. The problem is when I don’t get the direction right, or jump in too soon, my results can suffer- which points to some of the more volatile roller coaster like returns in the past.
I’ve been meaning to take up hedging/delta neutral trading, but I had a problem taking on an opposite position to my main position. To me , it felt like I was making a “bad” trade since I felt confident of the direction the market was taking. Working though this week’s problems helped me to see how to best use it with no reservations and better effectiveness.
For purely delta neutral trading, you don’t care about market direction as you are just profiting from moves in the market , hence the name “delta neutral” trading. Of course the more accurate one gauges the market range will result in better performance.
I find that I can employ my directional strategy with hedging to make profit on both the main trend and counter trend. The best part is if I get the direction wrong, if done correctly, it will be far easier to switch over to the right side with minimal losses since the position is hedged, and can easily be converted to a full delta neutral position. If I get the direction right, I now have the opportunity to make gains in both directions. In the past I’ve posted horror stories trying to be cute and taking a counter position, thinking I would switch back to the main position after I took a small profit, only to see the market move strongly against me so I wind up losing money being on the wrong side when I KNEW the right side to be on. With hedging, this scenario is a thing of the past.
My new methods mean I will no longer get stuck in bad positions like I was the last several weeks and most of February. It means I don’t have to worry that much anymore about using stop loss orders since the hedge will cover that. Couple that with my new intra-day trading progress, and it looks like a performance breakthrough is on the horizon.
The one drawback is that the new methods will require more action on my part to take advantage of both the trend and counter trend.
Comments (4)
I guess i need to read more about these terms, but in Delta Neutral trading, are you holding the stocks just a day or two? Or maybe even less? What about Hedging?
I’ll give you my week’s brief in many less words. Monday sucked, Tuesday sucked, Wednesday sucked, Thursday was ok and Friday sucked but that’s a given.
It really depends on what your price target objectives are. If you’re looking for a bigger move, it could take days or even weeks to finally reach that price level. Shorter moves can be done faster.
If you consider market movement as a series of waves, you have the main driving waves followed by back flow waves like you see at the beach, with the tide determining the main and counter wave direction.
Hedging is placing trades opposite your position to take advantage of pull backs as well as lower risk in the even the counter wave is strong and becomes or actually is the main wave. This means your hedge will likely be more actively traded than your main position, which has a targeted price level in mind.
Delta neutral trading isn’t time specific, but rather move specific since your primary objective id for the market to move in the range you’ve determined to take advantage of the price swings. Smaller price swings typically require shorter holding times.
They key with both methods is properly figuring out the market range of movement so you know when you should be selling or buying.
An example would be with Apple stock. When it was at $700, instead of selling, people could have bout counter positions as a hedge. Lets say someone had 400 shares of apple at that time and they though apple might go down for a bit before heading back up higher, so they take an opposite position selling the equivalent of 200 shares of Apple stock futures. Now you lowered your potential of making money by 1/2 going up, buy you also reduced your market risk by that amount as well. The big key is figuring out how long to hold the hedge, or if the main position should be abandoned in favor of the hedged one. One can also use options instead of futures but that is a bit more advanced.
Doing a search on Delta Neutral trading will give you some good info on how it works.
@Konrado - It was a tough week the market switch directions with enough force to do damage to both Bulls and Bears. If you can analyze what the market did to make sense of it, it will pay big dividends going forward. The mistake people make most is blaming these type of moves on news or other things as being purely random.