V.7:1 (21-25): Stock hedge portfolios: A strategy for all seasons by Larry Christy

Stock hedge portfolios: A strategy for all seasons by Larry Christy

If you're looking for a conservative way to make substantial profits in any kind of market environment, you may want to consider common stock hedge portfolios. By balancing an equal amount of your capital in long and short stock positions, you can reduce market risk and take advantage of the ability of some stocks to outperform other stocks.

For an example of the theory behind this strategy, just check The Wall Street Journal's listing of yesterday's biggest percentage gainers and losers among common stocks. On any given day, there are likely to be some stocks that have gone up considerably in price and some stocks that have dropped drastically in price. If you had previously bought the stock with the best gain and simultaneously shorted an equal dollar amount of the worst loser, your profit would have been the sum of the two percentage changes. On most days that would be in the 20%-to-40% profit range—far more than most investors usually make in an entire year.

I don't know of any reliable technique for picking the best and worst stocks on a daily basis, but I can show you how you can profit from the same basic strategy for conservative longer term investing. To get started you will need:

• A margin account with a stock brokerage firm. Although you do not need to incur any margin debt or interest expense for a hedge portfolio, brokers will require a margin account for handling your short sales.

• Enough capital to make it possible to diversify your positions among 10 to 25 common stocks on both the long and short side.

• A reliable stock selection method that identified both potential winners and losers.

• A few minutes a week to review your portfolio and possibly make occasional adjustments.