Written by David Fabian of FMD Capital Management. Hedging your portfolio is a strategy that is often employed by those who want to take out some downside protection against the possibility of a market drop. The most successful application of this process is to reduce your exposure in highly appreciated long positions with the assets that demonstrate inverse or non-correlated properties to the broad equity market.
This will allow you the flexibility of reducing your risk profile without having to shift your holdings to cash or disturb your existing cost basis in a taxable account. Playing defense in the midst of a correction or even a bear market may help you sleep better at night knowing that your capital has some layer of protection from a measured move lower.
Exchange traded funds make for a very easy way to access this type of strategy because they provide instant, transparent, and low-cost access to a variety of asset classes. You can shape your hedge to reduce stock market risk, interest rate risk, commodity risk, or any combination of those major groups depending on your needs.
For instance, the ProShares Short S&P 500 ETF (SH) is a popular way to play an inverse relationship with the S&P 500 Index. SH is designed to move inverse (or short) the same percentage move as the S&P 500 Index on a daily basis. According to ETF.com, this fund has seen net inflows of $728 million from the beginning of the year through February 9. This should come as no surprise given the strong down draft in the market and rush for protection that many investors are trying to capitalize on.
Read the full text of David's article at FMD Capital Management.
Editor's Note: Investors can also hedge with S&P 500 e-Mini futures. One suggestion is to maintain a steady long-term allocation of quality, dividend-paying stocks, but hedge at market extremes with the S&P 500 e-Mini.
Baseline Analytics tracks market extremes with its TrendFlex signals that help our subscribers determine when to hedge long portfolios.