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| Using Technical Analysis To Manage Risk And Maintain Top Quartile Performance |
By:
Dwayne Strocen 
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Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let's examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.
Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.
Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.
It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.
If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It's important that you do too.
Dwayne Strocen is a registered Commodity Trading Advisor specializing in analyzing and hedging Market and Operational Risk using exchange traded and OTC derivatives. Website: http://www.genuinecta.com
View in depth information about Who We Are
http://www.genuinecta.com/Trading_Financial_Commodity_Advisor.htm and the benefits of Hedging your risk
http://www.genuinecta.com/Professional_Hedge_Fund_Advisors.htm |
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