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How to Hedge a Portfolio

Different kinds of investors have different outlooks on the market. The reality is however, whether you’re a long-term investor or a day trader, you do stand to gain from implementing an effective hedge on your portfolio. With current market conditions showing some weakness and long-term outlooks appearing quite bleak, listen in this week for some advice on hedging your portfolio:

What is a Hedge?

It’s a term we hear all the time in markets and it is important to understand what a hedge really is. Host Andrew Baxter explains that a hedge is a position that you set up which profits should you lose value on your portfolio. Most of the time, this is an overall drop in the market. If your shares are set to fall by say 10%, you can set a hedge that would profit by the same amount should you see that happen. Overall, the result is a breakeven in spite of your share portfolio dropping off. There is a trade off however, as although you do protect yourself to the downside, you do not gain as much benefit from it if the market moves higher because your hedge position will lose value. 

Some Mechanisms for Hedging

There are multiple ways to go about setting up a hedge for your portfolio. The first example is shorting the market. The majority of your share portfolio is likely bullish and shorting the market is often the go-to strategy for an effective overall hedge on your holdings. One way you can go about doing this is short-selling futures. Short-selling can be a complex concept to understand, but once you have the basics it opens up exciting investing opportunities. It is essentially selling something now with the aim of buying it back later at a lower price, keeping the difference. Host Andrew Baxter notes that doing so with futures contracts in particular is difficult and the mechanisms for how it occurs are not always obvious. Alternatively, you can use put options. Put options increase in value as the stock price of the underlying shares fall.

A couple of key things to note – put options only operate for a limited time and there is a cost involved with placing this sort of trade for the rights that come with the put option position. Another common tool is short ETFs. ETFs offer a unique way of navigating the market – they can rise when everything else falls. On the ASX, an example of this is BEAR while for the S&P 500 you may look at the ETF with the stock code SH. The problem with these options is that you can only ever partially hedge, unless you have an amount of cash that matches the value of your portfolio. ETFs which offer leverage to increase your exposure without any additional output, however they are certainly not for beginners.

Some Examples of Hedging

As a seasoned veteran in the active trading space, Host Andrew Baxter has entered short positions on countless occasions. Whether this be in a speculative capacity or a hedging capacity, Andrew has used the strategies we have spoken about many times. When he previously helped take a company public, Andrew was in a position where he was in a massive profit but did not want to miss out on potential future gains. This is a feeling we can all empathise with as investors. He used put options largely while the stock was moving higher in order to secure a profit level should the stock come back down.

Andrew also regularly uses ETFs in order to get short and hedge his portfolio. It can sound like a lot of work to keep on top of your portfolio and regularly hedge it when needed, but the mentality of riding it out is dangerous. The ASX took 12 years to recover from the GFC, and not many people have 12 years to wait to simply recover what they had previously made. It can be easy to clock off when our portfolio is travelling well, and particularly if we are heading into a critical period of our lives, it is important to always be mindful of protecting yourself. Particularly now in these choppy conditions, make sure you are informed and prepared to hedge your portfolio against what may be around the corner. If you are looking to learn some more, get in touch with us and we will show you how!

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