Should I hedge my portfolio?
There is more to spread betting than the potential profits. Many experienced traders use spread betting to hedge their portfolio, limiting risk on their existing assets.
What is hedging your bets?
To hedge one’s bets means to invest in contrary but related markets. For example, if you own stock of several oil companies, you may hedge your exposure by shorting oil as a commodity. This way you are on both sides of the market.
Why hedge your bets?
Some analysts will tell you not to hedge your bets. Others point to hedging as a viable method for risk mitigation, albeit when done intelligently.
In the example above, you own stock in several oil companies but decide to short oil as a commodity. The reason you may choose to do this is because your stocks and the commodity oil are intertwined. The movement of one informs, to an extent, the movement of the other.
So logically, if all your stocks drop in price, you could expect to recover some of your losses from your short position on the oil market. In this way, you could prevent yourself from losing too much of your total investment.
Doesn’t hedging cap my profits?
The downside of hedging is that you can’t make as much of a profit. When you hold two contrary positions, they can’t both succeed. That’s why it never makes sense to buy and sell the same market at the same price – you can’t possibly profit, and you’ll just end up losing from the broker fees.
On the other hand, there are times when hedging isn’t going to completely handcuff you. Though it will always limit profits, the impact can be minimal when done correctly.
When hedging makes sense
Let’s return to the oil example. Using simple, hypothetical numbers, let’s pretend you purchased 100 shares of three oil companies, all for £10 a share. Your total investment is then £3000.
Hedging here doesn’t necessarily mean shorting the oil market for £3000. Instead, you might wait until your initial investment grows to a total value of £4000, then use a spread bet to go short on oil futures. This way, if the market contracts and your initial investment drops back to £3000, you may recover much of your initial profit from your spread bet. If the market continues to grow, you may recover the losses on your spread bet with the increased value of the stocks you own.
Hedging is most ideal when your portfolio is exposed to high risk. This could mean you have investments in volatile markets, or simply you have an undiversified focus. If all your investments are in gold, and gold dives, you could be wiped out. A portfolio with investments in hundreds of markets is in less need of risk management.
Why spread betting is good for hedging
You can hedge a portfolio with any number of trading vehicles, but spread betting is especially useful. The first reason is because spread betting gives you great flexibility. You’re able to open and close positions easily.
Secondly, it doesn’t matter the value of the market, you can place a spread bet for a simple per-point risk/return. In other words, you can hedge an expensive market without a large initial investment. Thirdly, spread betting often carries no broker fees, so it’s less wasteful when used to hedge.
So should I hedge my trades?
You’ll get different advice from different analysts. Just remember why you might consider hedging – to limit exposure in risky markets – and how to go about it. Don’t just make equal value trades on opposite sides of a market.
From here, it comes down to whether or not you’re comfortable with the level of exposure you have. If you’re fine with capping profits to ensure you limit losses, then hedging could be a beneficial approach.
Published: 8 August 2018
You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.