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Market Neutrality
Hi Amber,
So, is the market going up, or down? Bullish or bearish? One option some sophisticated investors opt for is to maintain a market neutral portfolio. The most common way, in the equity markets, is to take both long positions and short positions (through short selling) in an attempt to minimise the effect of the "market" on your returns, and increase the effect of individual security selection. For example, you could pick 10 or 20 stocks you think will go up, and buy them, and then find 10 or 20 you think will go down and short-sell them. If all stocks go down 20%, you should lose on your long positions and gain on your short positions, thus reducing the effects of the "market" on your portfolio, and your returns should thus rely more on superior stock selection skill. It isn't guaranteed, of course, as just because the market might go up or down 20%, it doesn't mean all stocks will follow that behaviour! A variation on this idea is "pairs trading", where (I think) long and short positions are taken in related securities. Let's say you think McDonalds is undervalued *relative* to Burger King, you could take a long position in McDonalds and a short position in Burger King, and provided you are right in your analysis, McDonalds should go up in value *relative* to Burger King... Which is an opportunity for profit even if they are both under or overvalued. Taking positions in related companies, like McDonalds and Burger King, also helps reduce the effects of industry-specific changes. If options are your thing, you could also try looking into using them in combination with stock positions, to hedge your investments. For example, buying shares and buying puts will protect from downside risk at the cost of some return (due to the cost of the put options). If you want more leverage, some financial institutions have "hedged loan" products, whereby you can purchase put options and the institution will lend you a greater % of the stocks you want to borrow, because the put options cap your loss. In Australia, Tricom Equities (www.tricom.com.au) offer such a product. So yes, if you're unsure if the market's going up, down, or sideways, perhaps consider one of the strategies above, or their many variations! Best Regards, Thomas Rice. :) Disclaimer: All the above strategies have their inherent risks that you should look into if considering them. Please consult a financial advisor before implementing any of the above. This isn't investment advice, but just some ideas to explore. :) > Good luck Elizabeth, with your options. > I know how it feels to lose money on options > since I was caught up in the drastic stock > market drop in the spring of 2000...and my > 'in the money options' became VERY 'out of > the money options' (meaning worthless) in > the blink of an eye! Since then, I have > continued my studies and have become a wee > bit wiser, I think. I have made money in > recent months by buying 'put' options > (rather than shorting stocks since put > options limit my losses) on extremely high > P/E stocks...but this is a very tricky > market and the wild swings are not for the > faint of heart. Even the pro's are having a > tough time being on the right side of a > trade. > I read an article today that was very > interesting. > He elaborates about the fall of the Nasdaq > but thinks that the next big market to > 'bubble up' may just be commodities. > Hmmmm...could he be right? As he says, > contrarians position themselves while no one > else is looking...and then are ready to sell > to the swarms of people who come 'late to > the party'. > The author of this article says: > "As the NASDAQ bust evolves, it > continues to be amazing that anyone remains > bullish on the index. Its fundamentals are > unbelievably atrocious and its technical > charts are ominous. Yet, humans being humans > with immense emotional inertia too great to > overcome for the majority of investors, tens > of millions of people are still fixated on > the last great bubble, hoping it will flare > up yet again in tech stocks, instead of the > next great bubble, probably > commodities." > The entire article is posted at the link > below. > If you are interested in what he says about > commodities, there is a hot link from this > article which takes you to another article > which builds his case for a coming bull > market in commodities....raw materials. > Just some food for thought... > I am trying to stay open-minded about where > the market goes from here, but it is wise to > pay attention to both the bulls and the > bears and to be prepared for anything. ;-) > Best wishes, > Amber |
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