Nothing is more frustrating than a single trade destroying weeks, if not months of work.
It’s a painful lesson I learned the hard way on multiple occasions.
During that stretch, I noticed I never stepped back to examine my trades as a whole.
I discovered periods where I had way too many bullish or bearish bets on in the market. My portfolio wasn’t balanced.
How do you maintain a balanced portfolio when you don’t want to give up on your existing positions?
In one word – Hedging.
For example, If you are long Google, you could short the Nasdaq 100 ETF.
You would do this if you believed that Google was set to outperform the broader market.
There are different ways to hedge your positions from basic strategies to complex ones.
The key is using one that works with your experience and style.
Today, we’re going to discuss various hedging techniques. And how you can start implementing them to protect your portfolio against any adverse reaction.
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Table of Contents
The Unprofitable Trader
Problem – I only know how to buy puts and calls
Newer traders probably haven’t thought much about hedging their positions. They’re more concerned with trying to come up with a good strategy and hitting consistent wins.
By ignoring your bias, you expose yourself to excess risk. I can think of several times when I would keep adding trade after trade on the long side. Then a day like Friday would come around where the market nosedives and all my positions turn against me.
The trick is to balance your trading risk and market risk. If you have a good idea, stick with it. Just know that it might not always work out.
Solution – Use market ETFs to offset your stock positions
My favorite solution for hedging – use market ETF options. I usually have a long-bias in my TPS trading strategy. To offset that bias, I will buy puts on major market ETFs like the SPY, QQQ, IWM, or DIA. This goes directly to the example I provided earlier. If I like Google’s potential, I reduce my exposure to the downside by buying put contracts on the QQQ.
The Breakeven Trader
Problem – I want to optimize my hedges
Sometimes I find myself in trades on similar stocks without even realizing it. If I play too many stocks in the same category, I get sector-specific risk. That means if I hold a bunch of tech stocks that all sell-off at once, using the S&P 500 ETF as a hedge won’t be very effective.
Solution – Use sector-specific ETFs
When I find myself too heavily loaded with one particular market area, I’ll look to offset the positions with the ETF for the sector. For example, if I have a trade in Biogen and Abbot Labs, I can pair these trades with a healthcare ETF to reduce my exposure. This reduces my sector risk and allows the trades to work on their own merits.
However, if you want exposure to the sector, then it’s best to cut down the number of trades in a similar category. Quite often, you’ll see the same setup in related stocks. When this happens, try to pick the best of the bunch.
The Profitable Trader
Problem – I don’t want to worry about adjusting my hedges all the time
Not every trader likes to spend time in front of the computer. I know plenty of swing traders that set their orders at the beginning of the week and then walk away.
The problem they run into is they don’t know which will fill and which won’t as the week goes on. They can very quickly find themselves with too many bullish bets or bearish bets.
Solution – Try market neutral strategies like iron condors
Strategies like short iron condors are great low maintenance trades. Once you put these on, you just check on them periodically for adjustments. These trades involve selling a call and put credit spread on a stock.
With these trades, you want to try to collect 1/3rd the distance of the spreads. For example, if you did an iron condor on a stock with a put credit spread at the $100/$101 strikes and a call credit spread at the $110/$111 strikes, you should try to collect $0.33 for the trade.
Ideally, you want to put these trades on when implied volatility is high and about 45-60 days out from expiration. With stocks, I try to avoid taking trades that go through any earnings announcements.
Putting It All Together
I won’t lie to you and say it’s easy to learn how to hedge your positions effectively. It takes time and practice. That’s why a good trade journal is critical. Your journal tells you what works and what doesn’t.
It took me years of practice before I finally learned how to turn a profit consistently. Journaling was a huge part of how I turned it around.
In my upcoming webinar, I talk about how I moved from an unprofitable trader to finally taking my $38,000 account and turning it into over $2,000,000 in just two years.
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