Hedge The Risk
A trader buys a stock for 100.
Suppose the trader decides that does not want to hedge his portfolio. The stock tanks down and comes to 75. But with time the stock does go back to 100. The stock thus moves back to the buy price and you thus do not see any reason to hedge?
If you look at the math then the drop from 100 to 75 was a good 25% drop. So when the stock drops it takes very little effort but when it goes up then this needs extra effort. The stock price also does not go up so fast until the market is very bullish.
So when you think that the stock market is going to go down it is best if you hedge your position.
The trader could also decide to sell off and then buy back at more alow price. This is something that is not easy to execute and since the transaction happens so fast the trader also has to pay taxes. This leads to more fees and charges.
All this means that the best way to protect your investment is to hedge the portfolio. This will let you stay patient without bothering about what is happening in the market. Thus even if there is any adverse movement in price it is not going to affect the trader’s portfolio.
You hedge the risks in the market
So when you say that you hedge in the market what exactly are you hedging? You hedge the risk in the market. What is this risk that you aim to hedge? Learn more about it.
Buying any stock of any company exposes you to risks. The risks are divided into systematic and unsystematic risks. When you buy the stock you face exposure to both these kinds of risks.
This is a form of risk and there could be other forms too which are specific to the company and could cause the company stock value to decline. This means that when the stock prices decline it does not mean that the other stocks will decline too. These are risks that affect only the company and this is known as unsystematic risks.
There is the other risk that still this is the systematic risk. The systematic risk arises because of the economic conditions and this affects the entire market. Fiscal deficit, tightening of interest rates, geopolitical risk, inflation and the degrowth of GDP are some examples of systematic risks.