4 Effective Hedging Strategies For Risky Long Positions
English: stock market board (Photo credit: Wikipedia)
In an uncertain world it’s good to have a strategy to that can protect one from danger. Danger comes in many forms, and in a modern society whose economy is driven by paper currency rather than barter, financial risk is one of those dangers that need to be addressed.
Surplus currency or the cash commonly used in commerce needs to be stored in a place of safekeeping when it is not needed for trade. It also needs to be invested appropriately to avoid the erosion of its value through inflation. These simple truths expose those who hold on to money, to the dangers of financial market risk. Offsetting that risk is the key to a sound financial future.
The Long and the Short of It
Fear is a much more powerful human emotion than greed, and those who trade the financial markets for a living know that the markets tend to travel along a gradual upward slope when they appreciate in price. In contrast to downward trending markets which generally collapse rather quickly, upwardly trending markets take a long time to mature, and that is why traders refer to financial asset acquisition trades as “long positions.” Profiting from a falling market requires establishing a “short position” which is the selling of an asset that one does not yet own. “Shorting” a market requires by rule the buying back of an asset that was sold earlier in order to liquidate such a trade. “Shorting” is an appropriate term to use because markets tend to take a shorter amount of time to go down.
Investors who trust their nest eggs to the equity markets know very well the dangers and risks of holding stocks long in volatile markets. For them, the industry has developed a set of strategies that can help them offset or “hedge” the dangers associated with risky long positions in stocks. The below methodologies have proven to be effective to achieve this aim, but every investor needs to check with their own investment adviser to determine if these are suitable and appropriate for them.
Dollar Cost Averaging
Dollar cost averaging is a simple strategy that calls for investing one’s capital a little it at a time, across time, and in different environments when asset prices have had time to cycle through up and down markets. The idea is to avoid investing all of one’s capital at just one price, but instead at different prices. When one engages in dollar cost averaging, they can take advantage of market swings and acquire at least some of their holdings when prices are relatively low.
Options as Insurance
Stock market investors have available to them a wide range of option contracts that they can purchase for a very small sum. Put options are contracts that will rise in value when stocks or the stock market as a whole declines. The purchase of put options can indeed be an effective hedge against risky long positions in stocks.
Binary Options
Binary options are a tool that can be deployed by both experienced and novice traders. In contrast to exchange listed options, binary options are very easy to understand once the investor takes the time to get to know them. There are only two outcomes (hence the name) with these contracts: A gain or a loss, and the loss is knowable upfront. Binary options can be used by stock investors to hedge the risk of a long position as well as enhance their existing profit opportunities. Binary options brokers can facilitate utilizing this investment tool for those that may not be so familiar with it.
Short Against the Box
As stated earlier, “shorting” a stock means selling shares that one does not own in anticipation of a price decline. Owning shares does not preclude one from profiting or hedging downside risk through shorting. One can buy a put option to protect the value of their shares, or instead go “short against the box” which means selling shares short in the market while simultaneously holding them long in the same brokerage account. This strategy completely offsets the risks associated with a volatile and risky stock market.
Category: Investing
