When Should You Hedge in the Stock Market?
The stock market is an interesting and exciting place to invest your money. It can be very complicated as there are numerous options to peruse. It can be very exhilarating but very challenging as well, especially if you are new to it.
One option you can take in the market is hedging. This may sound familiar but you may not know what it actually is. Think of stock market hedging not as a way to make a profit, but rather as a protection against risk. It can be thought of as an insurance policy against losses. It should be investigated wisely because it is not for everyone.
By definition, hedging means making an investment to reduce the risk of adverse price movements. In a normal market, a hedge means taking a position in a related instrument such as a futures contract. For example, if you have a stock then sold a futures contract stating that you would sell your stock at a certain price which would eliminate any fluctuations in your stock price. Typically an investor will use this strategy if they were unsure of the market. This way the investor is reducing his risk of the stock taking a nose dive. The only cost that would be realized would be the cost of the hedge.
Hedging is not necessarily an appropriate strategy for a beginner. However, if you are going to be a player in the stock market you should investigate hedging as it could be used to your advantage and most certainly to protect you against losses especially when you are uncertain of market fluctuations.
The best way to think of it is as a kind of insurance policy against a negative event happening. The stock market changes daily, therefore hedging can be a very useful tool to offset risks. Hedging doesn’t eliminate the negative event from happening with your stock investment; however it can protect you when it does happen. When you don’t know what the market will bring, hedging will cost you money to purchase but can save you big time if the market crashes (for example). If you are unsure of the market, hedging can be your answer.
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Hedging can be a great tool. I use inverse ETF’s to hedge my portfolio out when I think the market has peaked. I do not have to sell any funds to go to a more neutral position.