One of the most common ways, without selling your holdings is apply a hedged position. A hedge is where you make an investment to reduce the adverse effects of a negative price movement.
A great example would be during the credit crisis. If you had a heavy exposure to banking stocks you would have been hurt badly. However, hedging that position by going short the overall index they resided in, or that direct position would have covered the losses.Hedging is not for the faint hearted and passive investors. You will need to actively follow your position and implement strategic timing for the fullest effect.
There are many different methods of hedging a
position. A majority use derivatives to
execute, however they can be accessed by retail investors though the use of
exchange traded funds (ETF). By taking
a short position(betting that security will decrease) you can fully hedge your
long position or partially hedge it if you wish to reduce the volatility.
I mention reducing the volatility; by implementing a
short position it will reduce the movement your portfolio makes either up or
down. During times of uncertainty,
people use hedging to reduce the downside risk, investing long term after all is down to
protecting your losses and maximizing your gains.
You can purchase a volatility index, most notably is the
VIX index, this will provide protection in market crashes and if any
geopolitical event occurs. The VIX is currently
very cheap as people have come to terms with Eurozone risks and changing monetary
policy.
Another merit of using a hedge over selling the position,
is due to the nature of derivatives, you can leverage that position allowing
you to protect a larger proportion of your portfolio with one holding. An easily accessible leveraged trade is Soc
Gen 5 x leveraged short ETF.
So next time you go to sell all your shares when you
think the market may correct slightly, think again, hedging is always a
possibility!
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