Member Article

How to Get Maximum Market Returns with Hedges

Market investors can be differentiated on the basis of their decisions and investment strategies. The beginner investors are often like to take decisions of buying and selling stocks based on its perceived value. But, the professional investors formulate their investments and implement specific strategies to maximize profit and minimize the risk of the investment. Even you can employ the strategies like professional investors to get the maximum market returns. Let’s find out how?

Hedging to Avoid Market Risks

What is a “Hedge“?

In simple words, it is a way to isolate your investment strategies and protect yourself against financial losses. It is no different than a person who has a life insurance plan to support his/her family in case of his/her death.

By properly hedged, we can reduce the chances of happening of a negative event. We can avoid it by preventing ourselves with a hedge. As we know that the profits are directly proportional to the market risks. So, by hedging you will not reduce the potential profits, instead, you will have a sort of backup in case things go south.

Bottom line is: Hedge is like another investment which created to avoid the risks of main investment.

Most of all, hedge techniques is not limited to the individuals but also useful for corporations and portfolio managers.

How is it Works?

Any hedging technique involves the use of derivatives which by the way are quite complicated. But, we are not going to discuss it right here. All you need to remember is, by using these you can create a strategy where a loss in your one investment is offset by a gain in a derivative.

If you don’t get it by now then don’t worry. Because hedging is vast and quite complicated. The best way to understand is by assuming you own some shares of XYZ company and planning to stay invested for a long run but worried about short-term losses in the industry. So, to protect yourself from a fall in CTC, you can buy a derivative (a put option) on the company, which allows you the right to sell CTC at a specific price (strike price). So, if the stock price goes below the strike price then these offset by the gains in the put option (derivative).

**Note: - An investor can hedge against anything like commodity price, future & option, stock, and currency etc. **

Now the question is,

How can you design the hedge strategy for yourself?

If you still have no idea then you can follow the steps given below:

*** Select the cheapest hedge security that offers the sufficient protection needed. Don’t overspend on an expensive alternative with same benefits.

• Check for the Correlation Factor since it is very important as any variance which equivalent to unmitigated risk. And check for the negative correlation as well. **

**Note: - Make sure to use a basket of stocks or ETFs as a hedge and avoid individual stocks to minimize their own risks. **

Final Thoughts: -

No doubt, the hedge is no different from insurance and can be used to avoid the market investment risks and protect the investments for potential profits. The derivates are complicated but building a hedge strategy is quite simple. Just make sure to go through all the details above and if you have any query then don’t forget to mention in the comment section below.

This was posted in Bdaily's Members' News section by Advisorymandi .