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You won't believe how easy it is to hedge a portfolio strategy.
A hedge consists of reducing a portfolio risk by taking an offsetting position in a security. If you hold long positions on US stocks, you can hedge your portfolio by taking a short position on an S&P 500 futures contract, options or ETF.
If you hold short positions, you can for example buy S&P 500 futures contracts or ETF shares.
Hedging strategies can transform your trading system by reducing its drawdown and increasing its Sharpe ratio. The decrease in return can be compensated by increasing the portfolio leverage (margin factor).
The current money management script is very easy to use. You can add it to any trading system to instantly create a hedged strategy. The script contains three money management variables:
Security Symbol: This field allows you to enter the security to buy or short in order to hedge your portfolio.
It could be a stock symbol, example: short the stock of a competitor of a company whose stock you hold.
It could be an ETF to hedge a portfolio against market risk and sudden drop in the market. In this case you can buy the Short S&P 500 ETF (SH) or the ProShares Ultrashort S&P 500 (SDS) or short the S&P 500 SPDR (SPY) ETF.
Long or Short Strategy: Specify whether to go long or short the security specified above. Type 1 to take a long position and zero or any other value to take a short position.
Percent of equity to invest: This field gets the percent of equity that will be associated with the hedging strategy. The strategy is rebalanced every month.
Here is how it works:
- At the beginning, the trading system will buy or short a number of shares of the security you specified (Example: SPY) corresponding to the percent of equity defined (Example: 10%)
In long strategy with 100 000$ start capital, the trading system will use 10 000$ to short SPY.
- Each month, the number of shares of the SPY ETF is adjusted based on the percent of equity.
Example: if after a month the portfolio equity becomes equal to 120 000$ and the SPY position remains the same, then the new capital associated with the hedge will be equal to 12.000$ and therefore the trading system will use 2000$ (120 000$ * 10% - 10 000$) to scale-in the SPY position.
Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.
