Hedging the rise in equities

Despite a recent fall in benchmark equity indices in the dying days of January, the recent climb to record after record has put many in a mindset that they do not want to miss out on any other gains. So, how can you hedge against a rising market that you may feel is already over done? 

Technical analyst, Trevor Neil, drills down to explain why there has been this rise in indices and, using the chart of Netflix, looks at a good example in the parabolic move up for technology stocks.

Neil explains that there are ways to use hedging trades to ensure that you can remain ‘long indices’ while, at the same time, trade a recognised exchange traded fund (ETF) or index that can offer protection, should there be a sharp reversal.

Defensive strategies should, according to Neil, be as much a part of a trading plan as the idea of following trends.

Defensive strategies

  • sell short S&P futures, options, short S&P ETF or even ultras
  • sector rotation
  • theme rotation
  • volatility spike protection

The rise in the S&P 500 has been broad based, but a sizable minority, shown in the bullet points below, have been responsible for the ‘parabolic’ price action recently.

Among the S&P 500 components:

  • 117 have double-digit total returns
  • 232 have beaten the market with total returns of 6.4% or more
  • 408 have shown positive returns
  • one is flat
  • 35 are down 5% or more, including five that are down 10% or more

Neil also uses relative rotation graphs (RRGs) to anticipate where future moves could develop. Here, he says, that the information technology sector (labelled as S5INFT on the chart below), on the S&P 500, is fast moving from the yellow, or ‘weakening’ quadrant, into the ‘lagging’ red quadrant on the bottom left, an area where stocks become underperforming.

Conversely, those that have previously been underperforming, Neil says, will become the new leaders. Included here are utilities (S5UTIL) and real estate (S5RLST).

Whether it is ETFs or the Volatility Index (VIX), hedging should be a major part of any trading strategy.

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication.

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