Trade with a safety net
Summary: Outlook uncertain? Combat risk by hedging your positions.
It’s 3:30 EST, half an hour before the US stock markets close – and the key stock in your portfolio is about to announce earnings after the bell. While you definitely like this company’s prospects and want to keep the stock in your portfolio, you’re worried that bad news is about to send the stock tumbling. What do you do?
Hedge, don’t hope
Whether it’s an earnings announcement, central bank decision or overnight trade war salvo, traders need to be ready for risk. In the scenario we’ve described, some traders might sell before earnings – perhaps unnecessarily – while others may simply hang on to their stock, hoping for the best. And as any veteran trader will tell you, hope is not a valid trading strategy.
What those veteran traders might do is hedge. The good news is, you can do it too.
What is hedging?
Let’s start with what hedging is not. It’s not to be confused with hedge funds and it’s not only for professional traders. That said, hedging is an advanced strategy and you’ll need the right tools, such as put options or CFDs to go short.
Hedging lets you offset the risk of one investment by taking out another investment. For instance, if you short a stock in your portfolio with a CFD (Contract for Difference), you’ll be positioned both long and short in the same stock – and any loss in one position will be automatically offset by a gain in the other.
Think of hedging like a form of insurance – it can reduce the negative impact from unexpected events during a volatile period, such as economic data events, geopolitical developments or earnings calls.
Downside, meet upside
The clock is still ticking down to the closing bell. But rather than sell or just hope for the best, you’ve decided to hedge your position with a single stock CFD. CFDs are traded on margin, so you can easily take a short position and protect your portfolio while the market is volatile.
If your portfolio contains a lot of stocks from one index – say the Dow or the Hang Seng – and you think that volatility could hit all of your stocks at once, you can also short the entire index using an index-tracking CFD.
As a trader, you can never avoid risk entirely – but by adopting a hedging strategy with tools like CFDs or options, you’ll have a safety net whenever risk is on the radar.