My name is Anders Bøgebeck. My mission is to help you become a better investor and trader. Why is this important? We are not only helping ourselves by becoming financially free. Along the way we help society by either allocating capital the right places or creating better products and services. That's why I want to help you achieve the life you desire!
In this post, I will share my thoughts about risk-management techniques for your portfolio.
"Anyone can make money in a bull market." That's a rather bold statement, but I think there is some kind of truth to it. You can spot a beautiful trend in a stock with strong fundamentals and ride it. However, most people lose their money when the market inevitably turns around.
I will present some hedging strategies to avoid these scenarios.
1. Buy put options
The bad thing about put options is that you are long volatility. So if the market turns around but doesn't do it fast enough, it is an ineffective hedge. If you buy the hedge in a quiet market, you get it at a cheap price. However, in most cases you are just leaking money as the options expires worthless. That's the trade off.
2. Buy inverse ETF's
At a first glance, this seems like a better option if the broader market is trending down. Now you can ride the trend and make money from a falling market. The other good thing is, that you can keep this hedge for a long time as long as your stop-loss is not hit. The trade-off is that you must put in a hard stop-loss compared to the put option, which you can keep till expiration.
3. Long/Short portfolio
A great strategy can be to have long and short bets in the portfolio. In that case you erase beta (market risk) from the portfolio and your returns are only dependent on alpha risk. However, it can be really tricky to find these short opportunities in a rising earnings environment and the stock market is really bullish. So, unless you have special knowledge about a company or there are some obvious bets like Macy's (M) in 2019, this strategy is also very labor intensive.
4. A possible alternative solution
This alternative solution is based on a timing perspective. I don't think it's possible to time the markets perfectly. However, this simple rule can keep you out of a lot of big drawdowns, which are the number one focus point for a stock trader. It's called:
"The rule of 20"
The rule implies that you buy protection, either inverse ETF's or put options on a market downtrend, when SPY or QQQ prices are below the simple or exponential 20-day moving average. Remember, that you buy protection for your main positions, so if the hedge does not turn out to be really profitable, that is OK. In most cases, it will not work. However, you have to avoid catastrophic losses and reduce volatility at all costs. That is especially true, if you are using leverage, 2 - 3 times. Happy trading!
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