Reader Hedge Question

Reader John had this to say about his experience with the SimpleHedge Strategy:

Having read your ‘SimpleHedge’ Strategy document, I set up my own account in late March. Yesterday, my total gain went above 5%.

If I remember your approach to investment correctly, you generally recommend investing another third of one’s account once a 5% gain has been achieved. Since your Domestic TTI has also generated a Buy signal a few weeks ago, should I simply drop my short position from my ‘SimpleHedge’ Strategy account and put additional funds into the long positions? Your inputs into this transition would be greatly appreciated.

Let me clarify some items, since we are dealing with several issues. When I establish an outright long position, after a buy signal has been generated, I usually add to it once a gain of 5% has been achieved.

However, I do not use the same approach with hedges, although I suppose you could. Since you set up your hedge back in March, chances are that the original 50/50 ratio has become lopsided due to market activity. It is important that you rebalance back to the 50/50 ratio as soon as the hedge reaches an imbalance of 61%, as described in the e-book.

This will accomplish two things:

1. It will lock in some of your profits and

2. It will reduce your risk when the markets head south again. How? If you are in a 61% long position (and 39% short) you will lose more during a correction than if you are balanced in a 50/50 ratio.

If you wish to increase your hedge to make it a larger part of your portfolio, you can do that at anytime. I have done something similar with the hedge tracking portfolio featured in section 7 of the StatSheet.

If you are an aggressive investor, and believe the current bull market has more stamina, you can drop the short position altogether. I have done this for some clients whose risk profile fit the aggressive mode. Actually, it’s really not that aggressive, since we still work with a trailing 7% sell stop, which limits downside risk.

It all depends on you, there is no right or wrong. As you can see, starting with a hedge during times of uncertainty gives you more options later on to either increase the value of the hedge or become outright long.

Whatever you do, you always want to have an exit strategy in place to protect your portfolio from the next downturn. It’s not a question of “if” a trend reversal will happen, but “when.”

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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