Emergency Hedging «

Emergency Hedging

Most exchanges are now completely electronic, and are therefore very reliable, and very rarely experience any problems or downtime. However, when problems do occur, all traders (and especially day traders) need to have an emergency plan in place that they can use to hedge any open trades to avoid any losses.

Interestingly, emergency hedging is quite an advanced trading topic, but beginning traders need to know about emergency hedging before they even make their first trade, so for this reason, it is included in the day trading basics category.

Why is Emergency Hedging Necessary?
Emergency hedging is an important part of any trading plan, because the price of a market can change, even when an exchange is down. If an exchange goes down while you have an open trade, none of your previously entered orders (such as your stop loss order) will be able to execute, so if the price moves against your trade while the exchange is down, your trade will be unprotected. By using emergency hedging properly, you can protect your trade, and avoid any potential losses.

What is Emergency Hedging?
Emergency hedging is making a second trade specifically for the purpose of protecting a primary trade. There are a few different methods of emergency hedging. Some methods use options strategies, some use combinations of different types of markets (such as stocks and futures), some use other markets on the same exchange, and some use markets on different exchanges. Which method you decide to use will vary depending upon the trade that you have open, and the type of problem that is being experienced.

Emergency Hedging Example
A day trader has a long trade open on the ES futures market (the S&P 500 futures), which is traded on the CME. The trader is trading one contract, which is worth $12.50 per tick.

After a few minutes, the trade is a few ticks in profit, when the CME goes down because of a technical problem at the exchange. While the CME is down, there is a high volatility new release, which causes all of the US markets to start moving downwards (against the trade).

The trader wants to protect their trade so they enter a short trade (the opposite direction) on the YM futures market (the Dow Jones futures), which is traded on the CBOT. Each contract on the YM is worth $5.00, so the trader trades 2 YM contracts to almost cover their 1 ES contract.

From now on, whichever way the markets move, the trade’s profit and loss will remain almost the same, because the trader has open trades in both directions.

Compatible Markets
The above example uses a market on a different exchange to provide the protection for the primary trade. Some possible combinations of markets that can be used like this are shown below:

•ES (1 contract) and YM (2 contracts)
•YM (1 contract) and NQ (1 contract)
•DAX (1 contract) and CAC40 (2 contracts)
•DAX (1 contract) and SMI (2 contracts)
•CAC40 (1 contract) and SMI (1 contract)
•SMI (1 contract) and Z (1 contract)
•EUR (1 contract) and EURUSD ($125,000)
•GBP (1 contract) and GBPUSD ($62,500)

Other combinations of markets that can be used for emergency hedging include:

•Stock (100 shares) and Single Stock Futures (1 contract)
•Stock (100 shares) and Stock Options (1 contract)
•Stock on a US exchange (100 shares) and Stock on a European exchange (100 shares)
•Index Futures (1 contract) and Futures Options (1 contract)

Whichever method of emergency hedging you prefer, make sure that you are able to execute trades using the required markets. For example, US traders are not allowed to trade non US single stock futures (this is another SEC restriction), so if you are a US trader that trades European or Asian stock markets, you will not be able to use single stock futures as a backup.


  • New ETFs From Scottrade - No Brokerage Fees

    There's no doubt that there are more exchange traded products now than ever.

    classy, black-and-white Corsair Graphite 600T case that says sci-fi, not hot rod. I want to get like eight of these things, ...
    Read More
  • 14 ETF Trading Strategies

    You may have heard of ETFs and some of you even have them in your portfolios, but not many investors are aware of the diverse ETF trading strategies these assets have to offer.

    Read More