I have no doubt that regular Readers (please no Wheelie, I can’t take anymore purile and unimaginative All-Bran references), will be well aware of my borderline imbecilic obsession with Hedging my Portfolio and you must be exasperated beyond belief to see that I am writing about this well-treaded subject yet again. Anyway, it is what it is, and after the recent heavy sell-off in the Markets (which after all is exactly why I have been mucking about with Hedging for so many years, in anticipation and preparation for such an event) I feel it would be worthwhile to just get down in blog format some thoughts and observations etc. that have arisen after this episode and the Global tragedy of the Coronavirus.
Overall I am quite pleased with the Hedging I did although of course in an Ideal World I could have done it better. I guess my main area of weakness was in not Hedging in larger size (more on this in due course) and I would say another failure was in not getting a big enough Short on early enough. Other than that, and some moments of panic when I shorted more and really was lucky to get away with it, I am overall fairly happy.
In essence I had 2 phases of Hedging which was pretty successful on the first attempt but then on the second attempt the Markets keep going up and I closed out the Positions and took a small loss. However, despite how that sounds, I am quite pleased because I showed some discipline for a change and I was out before my Stoploss Levels were reached – so the damage was nicely controlled. The upshot is that on the successful Shorts I banked 8% of my overall Portfolio Value and on the Shorts that failed I took a hit of around 2% - so the net effect was 6% gain.
Of course, in the context of being as much as 28% down at the worst point for my Long Portfolio and at the time of typing this I am down 13%, then a gain of 6% for my trouble is not much (bear in mind though that I would be down 19% now if I had not Shorted). And of course now I am typing this and seeing the raw numbers it is not so great. It also needs to be appreciated though that at the lowest point my Shorts were probably up around 10% or more of my Portfolio so they were doing their job well and you can never trade at the exact bottom – in fact, you are an idiot if you even try (and a liar if you claim you do manage to hit the exact bottom !!).
Having said that though, it is important that I don’t just dismiss it as a waste of time because it has been far from that. As I said at the start of this blog, one of the things I could definitely have done better would have been to Short in a bit larger size – and this is something I need to think about and improve on in the future. In addition, had I Shorted in bigger size earlier in the drop, then I would have made a lot more as well and it would have maximized my use of Deposit Margin which of course was less ‘efficient’ when I was Shorting lower down and a lot of the fall had already been experienced.
Something that has surprised me is just how quickly the Indexes have bounced back and when I consider the potential impact of the crisis that has been caused by the Covid19 epidemic, it is quite crazy that Markets are not all that far from their All Time Highs. It is quite bizarre but when the Markets are doing weird things you need to recognise what is happening (at the time of writing this they are rallying hard) and you must trade with the direction of the Major Trend.
This also highlights a drawback with my Hedging in that I was getting my Shorts on in stages and at a controlled pace because I expected much larger falls and I was anticipating that I could make pretty sizeable gains on the Short side without necessarily having to rush to place my Trades. I was also thinking that a big drop would mean that I would have plenty of time to do some Long Index Trades to catch a chunk of the Bounce back but in the event that has happened much earlier than I thought I would.
I guess by previous standards this was one of the fastest drops in history and the Markets just pretty much fell through a trapdoor and were well and truly hung by the noose for their criminal behaviour of having got so stretched to the upside. In terms of the rebound, I think the Central Banks and Governments etc. have totally rigged the Financial Markets and their NIRP (Negative Interest Rate Policy) actions and huge amounts of Government Spending and Borrowing have almost made the Markets a one-way bet – and it is upwards.
But of course, when viewed in the round I am not too upset because of course my Long Portfolio of Shares and Long Spreadbet Positions have recovered quite promptly and I have gone from well over 28% down at the worse point (the 28% figure is offset by the Shorts I had running at the time, so the true Long damage was quite a bit more) to 13% down today – so there has been quite a significant improvement. I now have no Short Positions so I am pretty much 100% Long and I will talk more about that in a bit (actually with my Long Spreadbet on the S&P500 I am more like 115% Long now).
Had things played out as I expected, then I would have gained more on the Short tack on the way down and I would have gained a bit on the rebound – that is not what happened but at least I adjusted my stance fairly promptly and I am certainly pleased with that aspect.
Actually, on the subject of speed let’s cover that bit now. One of the big advantages/benefits of Hedging that I have always thought would be the case when tested in a proper downturn, is that Hedging is something that can be done extremely quickly and it can be removed with just as much rapidity. That has big appeal to me.
It is like turning a Light switch On and Off – Hedging On and Hedging Off very quickly and cheaply.
An alternative to Hedging is to sell loads of your Shares and to move a big chunk of your Portfolio into Cash. I know loads of people who have done this and when the Markets were tanking in a very scary and panicky kind of way, people who had moved into Cash must have been feeling a lot happier and must have been pleased with their earlier decision. However, on this rapid rebound I suspect the FOMO (Fear Of Missing Out) is absolutely eating them up and they are suffering a fair bit of psychological angst from being out of the Markets in a big way when Stocks are rising so well. They are no doubt thinking that Markets will drop again and they will have lots of time to feed the Cash in, but of course that might not happen for some time and a lot of gains could be missed.
Because of my Hedging and the speed with which it can be added or removed (just like flicking a Light Switch on and off), I have very speedily changed from a position of being about 50% Hedged (which is in effect like selling half of my Long Portfolio of Shares) to now being around 115% Long and fully invested – so I am taking full advantage of the gains in the Markets and I have none of the psychological pain.
I think this psychology thing is immensely important and I will mention it more in this blog no doubt.
Something else that occurs to me is that the way I have used my Hedges means that I have been able to take advantage of the rapid and sizeable bounces that many of the Stocks I hold have had off their bottom. For example, I hold Shares in AA (AA.) and they have been an absolute disaster for years and in the recent Sell-off they have got extremely beat-up to the point where the Market is pretty much expecting them to go bust (they might not). Now I was thinking about this. If I had sold a load of my Share Positions before the Sell-off got seriously underway (in other words, around the time I was starting to Hedge), then I would now have a load of Share Positions that I had kept but I would also have lots of Cash. Now the point is that if I had Cash (rather than Hedging) then I would never in a million years have the guts to buy Shares in the AA – and a few days ago for example they jumped up 31%.
OK, the AA is not the best example because even with the big bounce today the Shares are down a huge amount in the last few weeks, but the point is that I have lots of Shares that got really beat-up but have rebounded a lot and yet if I had Cash, I would never have bought them because I would have been too scared. It is great in theory to say you will buy Shares cheaply at the bottom but in practice we never have the balls to do it (and Ladies lack the whatever are the equivalent of Men’s goolies). A good example is On the Beach OTB which had a big jump a couple of days ago after a Trading Update came out and I am now very happy to be holding it but I am sure it is one I would have sold before the falls and I would lack the courage to buy it at the bottom. I am very happy to be holding it though because once the dust settles on this awful fiasco, I think OTB will be one of the strongest players in the Summer Holidays market and lots of competitors will have gone bust.
People who are in Cash now if they are brave enough to buy are most likely looking for lower Risk Stocks and ones that have held up well in the recent Market carnage – but it is the Stocks that are really High Risk and that have been massively beat-up which will be the ones that zoom up the fastest. And I have exposure to lots of those as well of plenty of Medium and Low Risk stuff.
So Hedging my Long Portfolio of Shares via Index Shorts has been a good way to avoid this fear issue when my Shares get really beat up – it takes that decision away completely and means I leave my Portfolio intact and I just have to worry about turning the Hedges Light Switch on or off at the appropriate time. It is much more mechanistic and removes all the emotion and the over-thinking.
Since writing the early drafts of this blog I have been thinking more about this and have had several conversations with people who moved into Cash and are now too scared to buy. I hadn’t really appreciated this psychological advantage of Hedging and it is a wider point than what I was saying in previous paragraphs about how I could in effect be buying quite High Risk Stocks – it also applies to any Stock (even relatively Low Risk ones) because what happens is that once you move a lot of your Portfolio into Cash it becomes very difficult to deploy that Cash again. It is clear to me that many People have become psychologically wedded to their previous stance of being Bearish on the Markets and are now unable to do a 180 degree turn and to go Bullish – yet the Markets are telling us that is the correct stance at this moment in time.
My Hedging has made this much more simple and much more mechanical. In essence, as soon as the Charts are telling me that the Shorts are no longer needed, I can very quickly ‘Turn them off’ (i.e. I Close the Shorts) and this is in effect just like buying a load of Shares and deploying all of my Cash in an instant. Provided I am disciplined (and that has been an immense and expensive failure of mine in the recent past), then my Stoplosses will trigger anyway and that is another mechanistic way in which the Market and its behaviour takes any decisions away from me.
There is also another effect – the way things have developed, I have actually been able to go Long on the S&P500 and this means that I not only have all of my Share Portfolio pretty much fully invested, but I also have additional Long Exposure and at the time of typing this I am up to about 115% Long and I am probably going to be adding to that Index Long within days.
At the fault of repeating myself a lot, but it is important, I want to add a bit more colour here as a result of a conversation I had earlier today with a mate. She has a chunk of Cash coming soon that she would like to invest and she is not a dedicated Share Investor or anything like that – so she needs something quite low risk and where there is little stress. Normally I would say buy some sort of Fund which buys Shares across the Sectors but at the moment I suspect that might not be the best idea. If anything, buying Individual Stocks that are perceived to be lower Risk and Dividend paying (ok, that has been a problem lately !!) is probably a better way to Invest and it is really a case of avoiding the troubled areas like Travel, Bars, Restaurants, some Retail etc. which might be very challenged for many months to come.
However, it is a really difficult one. But as I explained to my friend (who knows that I Hedge and how I do it) for me personally, I don’t need to make any such decisions. I suspect if I had any Cash I might be sitting on it and waiting at the moment to see how things play out over the year but because I am pretty much Fully Invested, I can simply bang on a Hedge if I feel nervous and the Charts indicate that I should Short and it things are good the Charts will tell me that also and I can remove the Shorts and even go Long on an Index if I fancy it (as I mentioned, I am currently Long on the S&P500 so in effect about 115% Invested).
Hedging gives a speed and agility that using normal Shares and moving in and out of Cash cannot possibly match. Especially if you are a very inactive Investor like I am (read ‘lazy’).
Yet another angle where I think Hedging in the way I have been doing can help hugely is in terms of reducing Trading Costs. I wrote a very detailed Blog about this some time ago and I will put a link to it at the bottom of this one.
And another rather more complex advantage of Hedging is that the way I use Spreadbets is that I have a Portfolio of Long Spreadbets on Individual Shares which in effect replicates my normal Share Portfolio. However, that is the theory but in practice it is not a perfect match and for instance I hold Team17 TM17 in my ISA but I do not have a Spreadbet on it – that has been an expensive mistake and I intend to put more focus into my ‘virtual’ Spreadbet Portfolio in due course but I keep getting distracted !!
Anyway, the point is that using Hedges in the way I do is much more Capital Efficient. If means that I can use a lot lower levels of Cash to support my Long Spreadbet Positions because when Stocks get battered, the Drawdown on my Stocks can be offset by the Gains on my Short Index Spreadbets – it works very well but you need to understand what you are doing and like with anything, if you fancy trying it then you must start in small size and experiment. In essence my Hedging enables me to run my Spreadbet Account with much lower levels of Cash for what I call the ‘Free Float’ or Buffer (on igindex I think they call it ‘Cash Available’ and when you ‘lose’ that Cash gets eaten up and when you ‘win’ the Cash goes up).
So overall I have been pretty happy with how my Hedging and my Index Strategy has worked during this difficult period for the Markets. It has had significant advantages in terms of speed of going Long/Short and reduced Costs of Trading substantially and it has also made the process far more mechanical and removed a huge amount of psychological angst which comes in the form of Fear on the way down and in terms of FOMO on the way back up.
But of course in an Ideal World I would have Hedged a bit bigger and got my Short Positions on both larger and faster. Ah, well, hopefully I will learn for next time in a similar way to how I appear to have finally learnt some discipline which I think is going to pay off handsomely in coming years and to have the effect that I can make good money in Years when Markets are Bullish and I can reduce the damage in Years when things are tough.
That is a lovely situation to be in and exactly where I wanted to be when my obsession with Hedging started a few years ago.
This Blog lays out in detail what my latest approach to Hedging and Index Trading is (there are links at the bottom of this one to the earlier bits):
This Blog is the one where I looked at the costs of moving into Cash as opposed to Hedging etc. (again links to the earlier parts are at the bottom of this one):
This Series goes on about how I manage my Spreadbets (links to earlier parts at the bottom):
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