Follow-up on Hedging

Follow-up on Hedging

On April 9^th I posted a piece on how I was hedging my investment portfolio to manage my risk in the market place. I had bought an ETF on the NYSE (RWM) that shorts the Russell 2000 about two weeks before I wrote that post.

I am now down just over 11 percent on that investment. In hindsight I regret making that move as it has cost me money in the in term.  However at the time I didn’t have the benefit of hindsight. I was facing an unknowable future and felt that risk was elevated in the marketplace. Looking back I now feel I put it on a little early.

So what do I do now? My feeling is that the underlying market is continuing to weaken under the surface of the market indexes. Market tops are like that. They can continue to go up, caught up in their own momentum and mathematics.The underlying breadth of the market (momentum of breadth) is weakening even as the major indexes continue their upward move. There is also some market rotation going on as the big money shifts its positions around. I'm going to hold on to my short for now and re-evaluate later on down the road. 

This is typical of the type of decisions an investor will have to make. Faced with the uncertainty of an unknowable future he will have to make a determination as of what to do based on the present market environment. If his decision doesn't work out, he shouldn't beat himself up over it. Its just part of the game of investing and dealing with a future where anything can happen. Right now my 'short' is still a 'work in progress'. As I feel the market continues to weaken I will hold on to my short and wait. Learning how to wait is a big part of investing.

Hedging

Hedging

Hedging is an attempt to protect your investment positions by making a counterbalancing investment within your portfolio. Why do I mention that at this time?

One of the jobs of an investor is to evaluate the current state of the market environment. Most of the time there is nothing to be concerned about. But every once in awhile the risk of a market sell-off becomes elevated and an investor would be wise to hedge his positions if for no other reason but to protect himself from himself psychologically. A violent market selloff can be a scary thing and will tempt the individual investor to run with the herd and head for the exits. Hedging your investments ahead of time is a way to protect yourself against this before it happens.

I keep track of the momentum of the breadth of the NYSE market (advancing  - declining volume) on a daily basis and smooth this data with various moving averages. I then subtract the longer moving average from the shorter one and this produces a trend deviation indicator (a form of market momentum). I use this to help me gauge the internal trend of the market. Both the direction and level of this indicator are of equal importance.

At this moment in time (April 9 2017) the underlying market is seriously deteriorating (money is flowing out of the market). It’s been going on for awhile. I feel a sell-off is eminent. Two weeks ago I bought an ETF that shorts the Russel 2000 index (it trades on the NYSE). It is a non-levered ETF that re-balances once a year so it is safe to use. Its symbol is RWM. I bought it a couple of weeks ago and have added to it since.

This is a way of managing my risk when I feel that the risk in the marketplace has become too elevated. It has nothing to do with predicting the future and is not a forecast.