Stocks & Commodities V. 25:1 (3): Q&A by Don Bright
SINCE YOU ASKED
Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question, post your question to our website at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
HEDGING THE MARKET
I was reading about taking opposite positions at the same time and referring to that as hedging. Wouldn’t that be the same as not being in the market at all?
Why put forth the extra effort of being in the market when you’re not going to profit either way? Or do I have this
completely wrong? — Iron Fist
The basics of hedging are this. You try to limit or eliminate “market movement risk” by being (for example) long 2,000 shares of stock A (the stronger
stock based on your criteria) and short 2,000 shares of stock B (the weaker stock). You then look back over a year, five years, and so on, and see if their prices have criss-crossed over time. If stock B is $3 higher than stock A, you would short B and buy A. If the prices crossed, you would make $3.00.
Another type of hedging is selling futures contracts at a premium to fair value, and buying the underlying securities. Then (often the same day) you reverse the trade at a profit by buying the futures at a discount and selling the equities (I’m using the Standard & Poor’s 500 or eminis in this example).