In this post, we’re talking about hedging.
Today’s question from Frank M: What about when the stocks which you have do go the way you want them to go, if your hedging is negatively correlated, doesn’t that mean they will cancel out the profits to some degree?
The answer to this question is YES, absolutely.
This is why that is the case.
When you have a basic portfolio
When you have this basket of stocks that make up your portfolio, typically, the general rule of thumb is that these stocks are heading higher. From time to time, they do have pullbacks.
Then sometimes they have some strong pullbacks. Let’s say Apple is moving really for you, well it’s sometimes wise to hedge. And the whole point behind the hedges to protect the things that are doing well for you.
When things get stretched, eventually, they pull back and come back. What you want to do is take a little bit of cash or capital. It doesn’t have to be your full account size.
Let’s say this is a 100% of your account.
You might break that with:
Next, you might get rid of some of those investments. Or take some more of that cash and buy yourself some protection. Or some other diversified fund that often moves a little bit opposite of what you typically have.
Of course, if your normal portfolio is heading higher, the other investments that you have maybe pulling back a bit. But it’s not a huge chunk of your investment. It’s a small part, so that way, when things pullback, it’s not as large of a loss or pain.
Focusing on TLT and GLD
Let’s say you have the TLT. Where typically, if stock market sell-off, the TLT or the bonds may had higher.
You can see here the TLT’s and bonds you know continue to increase and are moving well. So, you might be getting some of these.
Or you could look at the GLD.
It’s been moving sideways here lately, as you can see between 110 and 130.
This is the GLD spiders gold trust, so it’s an ETF for gold. The market overall has naturally been moving higher lately, But this GLD since 2013 has been moving sideways.
It shows you that it’s been stable, but it hasn’t been moving down and hasn’t been moving up. If the market sells off, it’s quite possible that this could move higher. Having some of this or maybe TLT, which is the US Treasury bond, could be a diversification for your general stock investment.
The whole point is not just to balance it out 50% of this 50% of that. It’s all about reducing your risk because when a pullback happens, what is it that you’re doing to protect yourself.
Moving your money around is important
If you have $20,000 and $5,000 of it is something like this that moves a little bit different than the overall market that might be more of a safer bet in a safer play. Then the other $10,000 or $15,000 that you have is just the overall market.
Moving your money around in different areas and spots in case it moves one big investment moves against you; at least you have some of the other things that help support you. And get you through the tough times.
That’s the whole point. Yeah, you might lose a little bit of money as your normal investments are moving higher. But when your normal investments are pulling back and struggling a bit, those other things could help sustain you. And let you live through to the next day, week, and month.
I hope that you now understand the whole point behind hedging. It’s all about protecting yourself and making sure that you’re a little bit diversified without putting everything in a single basket.
Otherwise, it could get horrifying when you put everything in one pie.
Most people diversify after they have a few grand in the market. Otherwise, the better approach might be to get an ETF and keep it simple.
Check those out, and it might work out for you. In either case, if you have a specific question that you want me to answer regarding trading or investing, then submit one here.