Market volatility is an inevitable aspect of investing, but experienced investors know there are hedging strategies that can significant🌄ly cut your exposure to risk, the same way insurance cuts down on your financial risks when own🧸ing a home.

Below, we review three hedging strategies to help protect your investments from negative market shifts: Modern portfolio theory's (MPT) diversification techniques, strategic options trading, and volatility-based indicators like the VIX. Whether you're a seasoned investor or building your first serious portfolio, these time-tested strategies offer practical ways to help protect your overall portfolio.

Modern Portfolio Theory

One of the main tools is the MPT, which uses 澳洲幸运5官方开奖结果体彩网:diversification to create groups of assets that reduce volatility. MPT uses statistical measures to determine an 澳洲幸运5官方开奖结果体彩网:efficient frontier for an expected amount of return for a defined amount of risk. The theory examines the correlation between different assets, as well as the volatility of assets, to create an optimal portfolio.

Many financial institutions have used MPT in their risk management practices. The efficient frontier is a curved linear relationship between risk and return. Investors will have different 澳洲幸运5官方开奖结果体彩网:risk tolerances, aꦐnd MPT can assist in choosing a portfolio for that par﷽ticular investor.

Options

Options are another powerful tool. Investors seeking to hedge an individual stock with reasonable liquidity can often buy 澳洲幸运5官方开奖结果体彩网:put options to protect aga💎inst the ris✤k of a downside move. Puts gain value as the price of the underlying security goes down.

The main drawback of this approach is the premium to purchase the put options. Bought options are subject to 澳洲幸运5官方开奖结果体彩网:time decay and lose value as they move toward expiration. 澳洲幸运5官方开奖结果体彩网:Vertical put spreads can reduce the premium paid, but they limit the amount of protection. This strategy only protects an individual stock, and it migh♏t not be cost-effective for investors with diversified holdings to hedge each position.

Investors who want to hedge a large, diversified portfolio of stocks can use 澳洲幸运5官方开奖结果体彩网:index options. Index options track 澳洲幸运5官方开奖结果体彩网:stock market indexes like the 澳洲幸运5官方开奖结果体彩网:S&P 500 and Nasdaq. These broad-based indexes cover many sectors and are good measures of tꦰhe overall economy. Stocks tend to be correlated, which means that they generally move in the same direction, especially during times of hig⛎her volatility.

Investors can hedge with put options on the indexes to minimize their risk. 澳洲幸运5官方开奖结果体彩网:Bear put spreads are a pos🅺sible strategy to reduce risk. Although this protection still costs the investor money, index put options can protect a holding consisting of long indices.

Volatility Index Indicator

Investors can also hedge using the 澳洲幸运5官方开奖结果体彩网:volatility index (VIX) indicator. The VIX measures the implied volatility of 澳洲幸运5官方开奖结果体彩网:at-the-money calls and puts on the S&P 500 index. The VIX is often called the fear gauge, as the indicator rises during periods of increased volatility. Generally, a level below 20 indicates low volatility, while a level of 30 and above is very volatile. There are exchange-traded funds (ETFs) that track the VIX. Investors can use ETF shares or options to go long on the VIX as a 澳洲幸运5官方开奖结果体彩网:volatility-specific hedge.

Of course, while th♛ese tools are certainly powerful, they cannot reduce༒ all market risk.

The Bottom Line

Investors use hedging strategies to reduce the 澳洲幸运5官方开奖结果体彩网:downside risk of their investments. Diversification, options strategies, and correlation analysis are some of the most effective strategies for creating a balanced portfolio. The most effective hedging strategies reduce the investor's exposure to market risk, without curtailing too much of the opportunity to make a profit.