You are on page 1of 8

Triangular Hedge

By Capella at http://worldwide-invest.org/
Assign 3 small whole numbers to 3 currencies called A, B and C, so that A = B * C., like this…
Currency 1 = EUR = A = 6
Currency 2 = USD = B = 3
Currency 3 = JPY = C = 2

From that we can combine into 3 different formulas like this…


A=B*C as 6 = 3 * 2
B=A/C as 3 = 6 / 2
C=A/B as 2 = 6 / 3

3 currencies forms 3 pairs as follows: A/B, B/C, C/A.


And (A/B) * (B/C) * (C/A) = 1 (using the above sample numbers 2, 3, and 6)
So EUR/USD * USD/JPY * JPY/EUR = 1
But there's no JPY/EUR, instead we have the opposite EUR/JPY, and when currencies in a pair have to change place, then
So the formula will be EUR/USD * USD/JPY * (1 / (EUR/JPY)) = 1
As a result, there can be 4 different formulas, depending on whether the currencies in any pair must be inverted or not.
The inverted pair is the one that is written within parenthesis.

Formula 1: Formula 2: Formula 3: Formula 4:


AB * BC * CA AB * (1 / BC) * CA AB * BC * (1/CA) AB * (1/BC) * (1/CA)

Formula for FPI = A / B / C, which gives 6 / 3 / 2 = 1

For instance: EUR/USD + EUR/JPY + USD/JPY (Buy + Sell + Buy, or Sell + Buy + Sell)
EUR/USD + EUR/GBP + GBP/USD (Buy + Sell + Sell, or Sell + Buy + Buy)
EUR/USD + EUR/JPY + USD/JPY (Sell + Buy + Sell, or Buy + Sell + Buy)

Pair Pair Order Bid Ask


A/B EUR/USD Buy at Ask: 1.37032 1.37037
B/C EUR/JPY Sell at Bid: 139.041 139.055
C/A USD/JPY Buy at Ask: 101.465 101.473

By making the calculation according to the formula for a triangulation we end up with a number that is near the value of
It shows how much imbalance there is in the hedge of the 3 currencies in the 3 pairs. The idea of trading is to open 3 suc
FPI for the above = 1.00002583 <= See K79 and below
FPI for the below = 0.99996750 <= See K79 and below

The colored currencies (yellow for EUR, green for USD and orange for JPY) are here hedged, except JPY which is almost h
Diff for the above = 139041 - 139039.5188 =
Diff for the below = 139055 - 139050.48136 =

Pair Pair Order Bid Ask


A/B EUR/USD Sell at Bid: 1.37032 1.37037
B/C EUR/JPY Buy at Ask 139.041 139.055
C/A USD/JPY Sell at Bid: 101.465 101.473

Note: In G35 (and G49) the lotsize is not 1 but the price for the base currency (first currency in the pair). Here at line 35 i
So the lotsize for the 3rd pair (C / A) in the triangulation is the price for the pair A / B (if the base currency A is found in t

We have 8 Majors:
USD, EUR, JPY, GBP, CHF, CAD, AUD, NZD

Which gives 28 currency currency pairs as follows:

EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, NZD/USD


EUR/JPY, GBP/JPY, CHF/JPY, CAD/JPY, AUD/JPY, NZD/JPY
EUR/CHF, EUR/GBP, EUR/CAD, EUR/AUD, EUR/NZD
GBP/CHF, GBP/AUD, GBP/CAD, GBP/NZD
AUD/CHF, AUD/CAD, AUD/NZD
NZD/CHF, NZD/CAD
CAD/CHF

For each currency there are 7 pairs as follows:


GBP => GBPUSD, EURGBP, GBPAUD, GBPCAD, GBPJPY, GBPCHF, GBPNZD
CAD => USDCAD, EURCAD, GBPCAD, AUDCAD, CADJPY, NZDCAD, CADCHF
USD => EURUSD, USDJPY, GBPUSD, USDCAD, AUDUSD, USDJPY, NZDUSD
AUD => AUDUSD, AUDJPY, EURAUD, GBPAUD, AUDCAD, AUDCHF, AUDNZD
EUR => EURUSD, EURJPY, EURCHF, EURGBP, EURCAD, EURAUD, EURNZD
CHF => USDCHF, CHFJPY, EURCHF, GBPCHF, AUDCHF, NZDCHF, CADCHF
JPY => USDJPY, EURJPY, GBPJPY, CHFJPY, CADJPY, AUDJPY, NZDJPY
NZD => NZDUSD, NZDJPY, EURNZD, GBPNZD, AUDNZD, NZDCHF, NZDCAD

Triangulation combinations. For each currency there are 21 tringulations as follows:


Note: The darker colors are inverted pairs The darker colors are inverted pair
A B C A/B
EUR USD JPY EUR/USD
EUR USD GBP EUR/USD
EUR USD CHF EUR/USD
EUR USD CAD EUR/USD
EUR USD AUD EUR/USD
EUR USD NZD EUR/USD
USD JPY GBP USD/JPY
USD JPY CHF USD/JPY
USD JPY CAD USD/JPY
USD JPY AUD USD/JPY
USD JPY NZD USD/JPY
GBP USD CHF GBP/USD
GBP USD CAD GBP/USD
GBP USD AUD GBP/USD
GBP USD NZD GBP/USD
USD CHF CAD USD/CHF
USD CHF AUD USD/CHF
USD CHF NZD USD/CHF
USD CAD AUD USD/CAD
USD CAD NZD USD/CAD
AUD USD NZD AUD/USD
a pair have to change place, then we must invert the calculation for that pair as 1 / (C/A)

any pair must be inverted or not. As follows below.

Buy, or Sell + Buy + Sell)


+ Sell, or Sell + Buy + Buy)
Sell, or Buy + Sell + Buy)

Lots Amount Curr 1 Amount


1 we got 100000 EUR we paid 137037
1 we paid 100000 EUR we got 139041
1.37032 we got 137032 USD we paid 139039.5188

number that is near the value of 1, but never exactly 1. We call this value FPI (Fractional Product Inefficiency).
he idea of trading is to open 3 such positions when the FPI is as far awy from 1 as possible and to close it as far away as possible on the

ged, except JPY which is almost hedged due to rounding error caused by too few decimals in the lot size:
1.4812 JPY
4.51864 JPY

Lots Amount Curr 1 Amount


1 we paid 100000 EUR we got 137032
1 we got 100000 EUR we paid 139055
1.37032 we paid 137032 USD we got 139050.48136

ency in the pair). Here at line 35 it is USD. Now check the price for this as quote currency (2nd currency in a par) against another curren
the base currency A is found in the first pair (A / B), or using the price for the 2nd pair B / C (if the base currency is found in the 2nd pa

Y, GBPCHF, GBPNZD
PY, NZDCAD, CADCHF
SD, USDJPY, NZDUSD
AD, AUDCHF, AUDNZD
D, EURAUD, EURNZD
, NZDCHF, CADCHF
DJPY, NZDJPY
ZD, NZDCHF, NZDCAD

There are two possible order sequences: B/B/S (S/B/B) or B/S/S (S/B/B)
he darker colors are inverted pairs. Different colors, see line 23 and 24 above!
B/C C/A Order 1 Formula Order 2
USD/JPY EUR/JPY B/B/S AB * BC * (1/CA) S/S/B
GBP/USD EUR/GBP B/S/S AB * (1/BC) * (1/CA) S/B/B
USD/CHF EUR/CHF B/B/S AB * BC * (1/CA) S/S/B
USD/CAD EUR/CAD B/B/S AB * BC * (1/CA) S/S/B
AUD/USD EUR/AUD B/S/S AB * (1/BC) * (1/CA) S/B/B
NZD/USD EUR/NZD B/S/S AB * (1/BC) * (1/CA) S/B/B
GBP/JPY GBP/USD B/B/S AB * (1 / BC) * CA S/B/B
CHF/JPY USD/CHF B/S/S AB * (1/BC) * (1/CA) S/B/B
CAD/JPY USD/CAD B/S/S AB * (1/BC) * (1/CA) S/B/B
AUD/JPY AUD/USD B/B/S AB * (1 / BC) * CA S/S/B
NZD/JPY USD/NZD B/B/S AB * (1/BC) * (1/CA) S/S/B
USD/CHF GBP/CHF B/B/S AB * BC * (1/CA) S/S/B
USD/CAD GBP/CAD B/B/S AB * BC * (1/CA) S/S/B
AUD/USD GBP/AUD B/S/S AB * (1/BC) * (1/CA) S/B/B
NZD/USD GBP/NZD B/S/S AB * (1/BC) * (1/CA) S/B/B
USD/CAD CAD/CHF B/S/S AB * BC * CA S/B/B
AUD/USD AUD/CHF B/B/S AB * BC * CA S/S/B
NZD/USD NZD/CHF B/B/S AB * BC * CA S/S/B
AUD/USD AUDCAD B/B/S AB * BC * CA S/S/B
NZD/USD NZDCAD B/B/S AB * BC * CA S/S/B
NZD/USD AUD/NZD B/S/S AB * BC * CA S/B/S
Curr 2 Calculation
USD (1,37032 x 100000 / 1)
JPY (139,567 x 100000 / 100)
JPY (101,465 x 137032 / 100)

Product Inefficiency).
and to close it as far away as possible on the other side of 1.

in the lot size:

Curr 2 Calculation
USD (1,37032 x 100000 / 1)
JPY (139,055 x 100000 / 100)
JPY (101,473 x 137032 / 100)

2nd currency in a par) against another currency in the triangulation (line 33 - F33).
C (if the base currency is found in the 2nd pair).

B/B/S (S/B/B) or B/S/S (S/B/B)