Over the past couple of weeks, I have featured two readers’ experiences in setting up a hedge as per my free e-book “The SimpleHedge Strategy.” Both understood the concept and applied it well.
Despite the markets having shown dramatic drops (-25%), followed by sharp rebounds (+27%) year-to-date, the hedge concept has held up extremely well. However, when markets move in such extreme ranges, it is important for you to rebalance once your hedge gets lopsided.
I touched on that in my e-book, but I want to further elaborate on this very important concept. Yes, you can simply set up a hedge and hold it, but you’d be missing out on a lot of profits as well as bringing more of the downside risk into play.
Let me show you the difference of what happens to your hedge returns if you’re simply buying and holding vs. re-balancing as I recommend. Let’s look at the period from 12/31/2008 to 4/24/2009, since we’ve had extreme volatility and violent swings in the market place:
1. Domestic Hedge using SH vs. 2 mutual funds (buy and hold): +1.75%
2. Domestic Hedge using SH vs. 2 mutual funds (re-balanced twice): +6.79%
3. Domestic Hedge using SH vs. 2 ETFs (buy and hold): +1.87%
4. Domestic Hedge using SH vs. 2 ETFs (re-balanced twice): +7.72%
These are dramatic differences that you need to be aware of, and the impact on the bottom line over less than 4 months is very impressive by any standard.
So when should you re-balance?
As you know, we always start out with a 50/50 ratio between long and short. I will re-balance to that ratio, once the hedge gets lopsided by 61%/39% in either direction. So far this year, it has meant that two adjustments were necessary.
This is a small price to pay considering the positive effect these changes can have on your portfolio. I am obliged to tell you that this past performance is no guarantee of future results; however, using a methodical approach in your investing endeavors will enhance the odds of you being successful.
Comments 5
Question:
I’ve always been an investor, not a trader. When I study trading, the words begin something like, “In a portfolio of 100K…”
Is it possible for someone with only 10K to set up a hedging position like you describe in your e-book? Since I’ve never done it, I don’t even know how much money it takes — minimum — to purchase ProShares or their equivalant.
Ulli,
What are your favorite two long and favorite two short ETFs for hedging?
Cornsilk,
My hedging strategy can be applied to any account size, whether you have $10k or $1 million, or more. It does not matter.
Ulli…
Anon,
I don’t have favorites, but I have mostly worked with SH on the short side.
Ulli…
Hi Ulli,
I have to admit that when you announced your "Simple Hedge Strategy" some time back, I remarked that it wasn't really that simple. After having studied it for a while I must say it really is quite simple, the easiest part is choosing SH for the short (bear) position, but the hardest part is selecting the long ETF or ETFs with a beta above 1. Yes using Yahoo Finance is an easy place to check the beta of any symbol. I have found for me that symbol VXF is above 1 beta and usually works well in an up trending market and is highly diversified. If I remember correctly it is based on the Wilshire 4500 and that is basically the Wilshire 5000 with the S&P500; removed. So for anyone out there who are confused about this strategy just keep reading and it will make a lot of sense eventually as it certainly has for me.
TrendMan