Tuesday, March 10, 2009

Hedging and Catching Falling Knifes

Investing in bad times
RE: Investing in bad times

williamlim Wrote:
Care to give advice on how you used hedgeing in your portfolio. Would the hedge amount be equivalaent to the total value of your long only portfolio or is it only up till the amount you think the loss in your long-only portfolio would be?

You have to shift your focus and view first. You hedge by going short when the market is primarily up, but showing signs of breaking. When the market is primarily down like today, your main positions should be short, while long positions become your hedge. What the majority of people advocate here is basically hedging without a primary (they think as long as price is cheap, it is ok to go long), not knowing that any long positions they have now should be viewed as a hedge.

You ask how I hedge my portfolio. The fact is, I don't. In times of volatility, hedging is redundant, and in fact makes things worse. Because I have very short trading timeframe, hedging becomes even more redundant. I oscillate between long and short positions frequently (usually with a combination), and I use stop loss to control risk.

The best and only true leading indicator is sentiment, because sentiment is the one thing that arrests the correction and ultimately switches it back to up. Read this again carefully:
p9939068 Wrote:
The second is just plain common sense, but it's really difficult to drill in. For stock markets (NOT economy) to turn up, the FIRST step is for private equity to have confidence in AT LEAST the NEXT earnings report. Now ask yourself, do you think companies will start posting increased earnings in the next quarter?

After reading this, you will have to find your own answers as to what will start encouraging private equity to regain confidence, and not look for some indicating signals (like BDI etc, although they can be useful). Instead, look out for events that are critical to regaining confidence.

Lastly, if you "die die metal teeth" only interested in long positions with a long term view, then remember not to catch a falling knife. Lets simplify things and think of the economy as a perfect "U". You want to enter the market at the right side of the U, not the left. In the left, you don't know how low it can continue to go. In the right (with the right signals), you can be assured it's going up, even if you miss the bottom (which you will anyway if you enter on the left).

Furthermore, and quite importantly, there is a chance we have be looking at an "L" economy. This means you will have much more time at the right side to decide when to enter the market, without missing the bottom much.

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