Trading 101

Article #4: Portfolio managing and hedging

Portfolio management is the key aspect for any trader. There are several reasons for this. Firstly, it helps you to manage your single intraday positions better. And secondly, it helps to overcome the noise on the market after the news, when you have diversified your portfolio with several trades.
That’s why in this small article I will turn your attention to some of the main parts of the portfolio management.

The portfolio management has two major divisions — active and passive. Both of them implement different strategies for extracting money from the market. The active approach most commonly involves a team of managers who attempt to beat the market return by actively managing the portfolio. It is based on deep and complicated researches, quick investment decisions, trades and hedge executions at the professional level. On the other hand, the passive approach is simply tracking the market index and respectfully its performance.

The asset allocation is one of the key elements for efficient portfolio management. Finding the right mix of assets is very important for your future portfolio developing. One has to understand the different types of assets, what makes them move and that some of them are more volatile than the others. The asset allocation is aimed to maximize the return and minimize the risk by selecting assets with low correlation to each other. Furthermore, the investment strategy is dictating the asset allocation as well. If the strategy is aggressive then it will acquire more volatile securities and if it is conservative and defensive it will acquire more stable securities.

Next comes the diversification. It is well known that it is impossible to constantly predict the winning and the losing positions in your portfolio. This way the diversification is spreading the risk and reward between the different asset classes. Because it is different to analyze which particular securities are going to outperform others the diversification captures the returns and measures the volatility of all the sectors. Proper diversification encompasses different classes of securities, sectors of the economy and geographical regions.

And last but not least comes the hedging. It is a very widespread technique but unfortunately, many traders do not possess the knowledge of how to use it. The most common mistake is to skip the detailed analyses and proceed with hedging your portfolio just with securities of negative correlation. It might work in theory but nowadays the correlations are interrupted very easily and could flip quickly. In this case, try to hedge the securities that you have already traded, in order not to risk your capital. This will bring you confidence because you know the bases of your hedge in details and you know how it will react to different news and situations.

However, most of us are not big fund managers and don’t operate with millions and don’t have the resources to follow the portfolio management approaches in their full aspect. But many of the basic rules could be implemented even from intraday traders. Because as soon as you have several open positions you are a portfolio manager no matter the time frame. And it is important to manage them correctly. You can always spread your positions in different sectors and select securities with different volatility in order to attempt to beat the market in any time frame. And by the correct usage of hedging, you will be able to extract as much as possible from your relatively long-term positions.

Written By Valentin Fetvadzhiev

04.04.2018