Other ways to assess risk, and hedge in the market
A smart thing you can do when it comes to securing your positions in the market is to actively monitor them yourself. You can then reduce your size in volatile markets and during uncertain times. If there is a lot of uncertainty due to political or macroeconomic contexts, the uncertainty in the financial markets may increase. We then have an index called the VIX, which is a ticker of the "Chicago Board Options Exchange Volatility Index". This index is also called the "fear index", and follows the volatility in the market.
If the VIX is high, it is a signal that something is going on in the markets, and that you should be more careful as an investor. Historically, this goes down over time but has extreme peaks when the uncertainty is at its highest. The VIX index is usually negatively correlated with the S&P 500 Index, in fact, the inverse correlation between these has been -81% during the last two years.
The VIX index was created by the CBOE in 1990 to serve as a benchmark to measure the volatility expectations of the future stock market. The index reflects market participants' expectations for volatility over the next 30 days. Simply explained, it does these calculations by monitoring implied volatility on options for the SPX index. You can find more information about VIX here.
There is a quote that says; "Be fearful when others are greedy, and greedy when others are fearful". This is something you can think about if you want to be a contrarian investor. If you look a little closer, it is when the VIX index spikes that you should buy stocks, as these peaks mark most bottoms in stock market corrections. However, you should be careful to use this as the only indicator, as it is always difficult to capture an exact bottom during a correction. This contrarian indicator should therefore be used in conjunction with other such contrarian indicators if you want to try to "time" an entry during a falling and fearful market.
Hedging in the market
As protection against risk and declines in the stock market, you can either reduce your holdings when the VIX index begins to gain momentum or secure your positions by holding specific instruments/options. This means that you can have instruments/options that follow the VIX index directly and give you a positive return to outweigh the fall you may have in the rest of your position during such corrections. This is often called "hedging" a position.
There are also a number of ETFs that hold futures on the VIX index. You can consider buying these in times of higher volatility. Remember that such ETFs always lose money over time, and are only meant to be held in the short term as a "hedge".
Another option is to buy bear (negatively correlated) market instruments or bear (negatively correlated) market ETFs. You can then buy these as a "hedge" against indices that you are exposed to with your existing portfolio. These bear instruments can be ETFs such as:
A larger list of such ETFs can be found here. Most of these instruments can be bought through most stockbrokers.
As with the VIX ETFs, these bear products always lose value over time and are only meant to be held when the markets go down and are very volatile.
As you can see from this historical 20-year long graph, the US indices have a significant historical difference of when they experience high and low returns through a year. You may therefore want to follow this seasonal cycle of stocks and indices. Nothing is certain in the stock markets and nothing is 100% alike, but it can often be a good idea to look at history to find good ways to be prepared for what might happen next. By using this indicator, you can then have less time in the market, which significantly reduces the time at risk of your portfolio.
There can be great market and individual portfolio risks during volatile markets. It is in such cases that you should consider whether you have good enough stop-losses and whether these offer adequate security. You should also consider reducing portfolio exposure and size during such periods.
If you absolutely want to keep your portfolio in the market during high volatility and corrections, you can, as shown above, consider buying additional insurance via options and financial instruments. As mentioned in the conclusion for beginners, risk management is the most important thing you can learn as an investor. It is the no.1 tool for preserving capital.
In the book Market Wizards, some of the best investors of all time are interviewed and asked questions. When it comes to the question of what was behind their success, the vast majority answered that managing risk was the most important thing when it came to their success. As a little reminder:
RISK MANAGEMENT = SUCCESS
risk other ways to assess risk hedging in the market securing risk in the market other ways of assessing