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Portfolio Hedging: The Right and Wrong Way

January 04, 20243 min read

Investors are a strange kind of people; they can be bold and fearless when making investments, or they can be afraid of the market. They're the ones that tame the market and make money in the process. Yet, they can also lose everything in the process.

To protect themselves, savvy investors include hedging strategies in their portfolios. These strategies are basically investments made without profit in mind. Instead, they're made to safeguard money against potential volatility and market disruptions.

There are right ways to hedge a portfolio, and there are wrong ways. Hedging your portfolio correctly can make it a strong and robust machine that makes and protects your profits. Yet, hedging your portfolio incorrectly can cost you everything.

Keep reading below to learn how to hedge your portfolio correctly, and exactly what hedging is!

Hedging Your Bets Means Making More of Them

When investors develop a hedging strategy, they identify commodities that seem like safe bets. These commodities are usually removed from the investors' typical markets. So to hedge a portfolio, an investor whose portfolio focuses on tech and retail stocks may purchase real estate property.

This way, if something disrupts the tech and retail markets, the investor is still safe because they have real estate property. Real estate isn't affected by the tech and retail markets, so it won't lose value. They'll be able to start recovering their losses right away, instead of being left with nothing.

The Wrong Way: Trying to Make Money From Hedged Investments

Sometimes, investors try to make money by implementing strategies that are traditionally used just to protect other investments. For example, an investor may choose to 'short' a particular stock, if they believe it's overvalued. Usually, investors wouldn't put too much cash into the 'short,' since it's just a way to make money in case the market takes a downturn.

Yet, investors may sometimes make the bulk of their portfolio from 'short' options. If they do this, investors risk losing all the cash they put into the option if the stock actually retains its value. Trying to make money off of hedged investments exposes investors to more risk, instead of mitigating it.

The Right Way: Hedging to Protect Other Bets

Hedging a portfolio the correct way just takes common sense. There are also tons of strategies a savvy investor can use to protect their portfolios.

For example, if you think that the market will soon make a downturn, you can set aside money to use for 'put options' on specific stocks. It's obvious that retail stocks will lose value after spiking during the holidays. To stop yourself from losing money, you can bet that the stock will lower to a certain price by a certain point.

This is called a 'put' order and can help you protect your money. With them, you can keep your regular portfolio intact and mitigate risk — even if the market tumbles, you'll still profit! And that's just one strategy out of many that you can use to protect your money.

Hedging is a Sound Strategy if Done Right

Hedging your portfolio is preparing for the inevitable. The market can't always be profitable, and by making bets that it will fall at some point, you can preserve longer-term investments. Hedging isn't a way to make money; instead, it's a way to protect your market position.

David

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