Hedging shares: How to successfully protect your portfolio!

It's hard enough to generate profits on the stock market - the last thing investors want is to lose them again! Fortunately, there are several ways to hedge your portfolio. In this practical guide, we will focus specifically on the Hedging of shares under the microscope. 

Why should you hedge shares?

Investing in securities is undoubtedly one of the most lucrative forms of investment. However, a look at the average return shows that the typical investor tends to produce disappointing results. In the long term, his profit is only around 4 % per year. By comparison, the S&P 500 share index would have generated an annual return of 10 %. 

There are many reasons for this weak performance, but one A central problem stands out: the incorrect handling of setbacks, price slumps and crashes. Anyone with a long-term equity portfolio will inevitably be confronted with falling prices sooner or later. It doesn't matter whether you Blue chip shares or unknown titles, how well you know the Fundamental analysis or how positive the market outlook is at the moment. 

A look at historical data shows that such negative market phases very frequently are. 

• Corrections of up to 10 % occur approximately every 1.2 years 
• A crash with more than 20 % price drops occurs every 5.6 years. 
• The gains following such a crisis are always considerable and usually quickly make up for the losses. 

An ideal scenario for investors: Avoid price losses and benefit from the subsequent recovery! Those who fend off the regular setbacks would have a significantly higher total return achieve. Hedging one's own portfolio is therefore at the top of most investors' to-do lists.

In reality Hedging shares is no easy task. The individual methods that can be used for this purpose each have their own disadvantages. In addition, price declines are generally unpredictable, meaning that investors often make mistakes. 

Nevertheless, protecting your own portfolio is one of the most important tasks. Successful hedging distinguishes the private investor with mediocre results from a high-caliber investor who beats the market. 

Protect your securities account: You can protect your shares with these methods 

Hedging equities can be a considerable challenge. Above all, investors must Two central problems master: 

1. All hedging methods have disadvantageswhich can range from costs and a large amount of work to additional risks. Advantages and disadvantages must be weighed up and used strategically. 
2. The best protective mechanism is useless if it becomes a wrong time is used. The hedge must be in place during the price slump, which is not always the case in practice. 

Also the Selection can overwhelm newcomers. It is not always clear which hedging method is best for a portfolio. We have therefore compiled the most important methods, their advantages and disadvantages and the ideal time to use them for you below. 

1. diversification

Diversification, i.e. the Allocation of own investments to different assetsis a basic method of hedging your own portfolio. If a single share only makes up a small part of our portfolio, the damage in the event of a price drop remains manageable. 

Conversely, we would lose considerable sums if we invested all our capital in a single security (no diversification) and its price fell. 

There are various ways to hedge equities in this way. In order to protect a portfolio, we can diversify the assets it contains based on various aspects: 

• Asset class: Few investors bet everything on shares. Gold, real estate, Short-term bondscryptocurrencies and other classes are part of a balanced mix. In this article, we look specifically at hedging equities and leave aside the question of what percentage they should make up. 
• Region: Economic developments are often (but not always) limited to individual economies or regions. A portfolio consisting of European, North American, Japanese, Chinese, British ... shares would be broadly diversified. It would be much better able to compensate for crises in individual countries. 
• Company size: Large, medium-sized and small companies all react differently to economic developments. Diversification between shares in companies of different sizes can therefore reduce your overall risk.

• Industry: Cannabis Shares react differently to market developments than AI shareswhich in turn react differently than Copper shares... A well-diversified portfolio should therefore definitely include securities from different sectors!
• Risk and volatility: Some companies are characterized by almost immovable prices, while other share prices move like a rollercoaster. If only highly volatile stocks are held in a portfolio, there are considerable risks. However, those who focus exclusively on stable shares often achieve lower returns in the long term. So here too, the mix is crucial. 

When using a diversified equity portfolio, a Regular rebalancing is recommended. The ratio of securities within your portfolio may shift due to different price developments. During rebalancing, the Balance adjusted again through purchases and sales. 

Rebalancing and general trading with several shares can quickly lead to high costs. Therefore choose preferably a favorable broker, so as not to attack your return unnecessarily. 

Correct use - How much diversification is too much?

A sufficient allocation of your own investments is ideal for hedging equities. Now one could assume that More diversification also means more security offers. This is However, this is only partially correct. A portfolio with thousands of securities provides, for example not automatically more security than one with a manageable selection. It can even lead to the opposite results!

To create a Sensible maximum limit for diversification different perspectives must be taken into account: 

• In an analysis of Investment Fund with different portfolio sizes shows that funds that invest in fewer than 50 companies achieve a slightly better average return than providers with more securities. 

• Star investor Warren Buffett is known for his statement that an "investor who understands an industry needs no more than six companies in his portfolio". As the best-known fan of Value-Aktien he focuses on a few companies with gigantic growth. "Very few people," Buffett continues, "got rich with their seventh-best idea. 

• The protective effect of additional shares decreases as the number increases. While the acquisition of a second security still significantly reduces the risk, further purchases only lead to smaller and smaller reductions. A portfolio with 32 shares has already achieved 95 % of the protection possible through diversification. 

Diversification has a strong effect on risk at the beginning. However, the positive effect decreases as the number of shares increases. 

• On average, women are better investors and outperform their male colleagues.
  • Studies ("2021 Women and Investing Study", Fidelity Investments, 2021 and "Boys will be boys; gender, overconfidence, and common stock investment", Brad M. Barber, Terrance Odean, University of California, 2001) found a higher return of 0.4 % to 1.44 % per year for female investors compared to male investors. 
  • The biggest difference can be seen in the success of single women vs. single men. 
  • An important difference: women invest in portfolios with fewer securities and trade less often - up to 67 % less than men! 
  • Women are also more cautious, act more conservatively financially and are less convinced of their abilities as investors.
  • Fewer shares and cautious investment therefore seem to be an advantage.

• In her widely acclaimed review "The Capitalism-Distribution" ("The Capitalism Distribution - Observations of individual common stock returns 1983-2006" Eric Crittenden, Cole Wilxoc, 2006), the authors Eric Crittenden and Cole Wilcox show that only a small number of shares are responsible for the profits of a large index. They take a closer look at the Russell 3000. This index is based on market capitalization, so that the largest companies also account for the largest share. 

In the period under review from 1983 to 2006, all the gains in the index were attributable to just 25 % of the shares. The remaining 75 % generated a total of zero profit!

The entire gain of the index under consideration was generated by only 25 % of the shares. The other 75 % generated a total gain of 0 %. 

The aim of all investors should be to add the profitable 25 % to their portfolio while avoiding the remaining 75 % of companies. However, with each additional security, this is likely to become more difficult to catch another profit maker. A portfolio with hundreds of stocks is therefore very likely to dilute our total return more and more. 

The The typical recommendation for hedging your portfolio is around 25 shares. This amount is consistent with most study results and the experience of experienced investors. However, it is important that these Titles sensibly distributed across various sectors and regions are ideal for hedging the shares. 

2. order forms

Shares can be very simply through stop orders, Stop-loss orders, Trailing stop ordersrelative limit orders and other forms. Such instructions to your broker are executed as soon as the specified parameters have been met. 

In the simplest form (stop order, stop-loss order ...) the shares are sold if they fall below a predetermined price. This prevents further losses. However, you will also lose the securities in question, but you may be able to buy them again later at a lower price. 

The decisive factor here is what distance to the current price a stop order is placed: 

• If the stop order too close to the current priceIt will be triggered by even small price fluctuations. Your share will then be sold, even though it may only have been a typical up and down movement on a trading day. As a result, you will miss out on future profits. 
• At too large a distance a considerable loss is incurred in the event of a price slump. The hedging of your share then only takes effect late and the damage has already been done. 

Which distance is ideal, depends heavily on your risk capacity and long-term goals. For example, a stop order at a distance of 10 % from the purchase price is popular. If the price falls by at least 10 %, it would trigger a market order and sell the securities. 

Please note that the loss in this case can be more than 10 %! A stop-loss order is executed as a market order at the best available price - however, this can also be significantly lower! 

More complex order forms often offer better protection for your shares. Multi-level rules are known as Algorithms and can provide ideal protection without jeopardizing your profits by triggering them too early. In return, however, they also require a greater understanding of the financial markets and can have undesirable effects if used incorrectly. 

Unfortunately many brokers only offer an inadequate selection of order forms. This can make it difficult to hedge your shares effectively. We therefore recommend ensuring that you have an appropriate range of orders and algorithms when setting up a securities account. 

3. hedging shares with options

Options are classified as derivatives and offer traders comprehensive strategic opportunities. However, the potentially very lucrative contracts are also considered somewhat more difficult to master. Fortunately only a very simple option strategy is required to hedge shareswhich even newcomers can learn without any problems. 

All that is required is the Basic functioning of options be understood: 

1. Options are contracts between two trading partners, the buyer and the seller.
2. Both parties agree to trade a commodity (e.g. a share, ETF, commodity, etc.) at a fixed price at a point in the future. 
3. The object of this transaction can be either the purchase or sale of the goods. 
4. The buyer of an option can decide whether he actually wants to execute the trade. The seller has no right of choice and must execute the transaction at the buyer's request. 
5. In return, the buyer pays a fee to the seller, which the seller may keep - regardless of whether the trade is executed or not. 

Options contracts are particularly interesting because traders can act as buyers and sellers and agree buy and sell transactions. For the HedgingThe most common way to hedge shares is to buy an optionwhich includes a right to sell. In technical jargon, this is referred to as a "Long Put". 

If you have a long put option, you receive the right to buy or sell the "underlying" (in this case the share that is to be hedged) for sale. The price for the share is determined when the option contract is concluded. You have this Sales price thus secured. Even if the share price falls to € 0, you can exercise your option right and sell at the agreed price. 

• A fee is charged for the purchase of a long putthat you have to pay to the option seller. The amount depends heavily on the price you want to guarantee. If you agree a lower selling price, the costs will fall. However, if the share price falls, you will also receive a lower price. Your shares are therefore less effectively hedged. 
• If you choose a higher price, your share position is better protected. You can even opt for a value above the current market price and thus theoretically make a selling profit! However, such an attractive option contract will also cost you considerably more in fees. Whether a specific option is worthwhile for you must be decided on a case-by-case basis. 

How does a long put help to hedge my shares? 

Quite simply: 

• If the share price falls below the value agreed in the option, request the Exercising your option right. The other party must now buy the securities from you at the agreed price - no matter what they currently cost on the stock exchange! You have sold your shares at an attractive price and thus prevented a loss. You only have to bear the costs of buying the options. 
• Should the However, if the share price does not fall as expected, simply refrain from exercising the option. You keep the securities in your custody account, but have to book the premium paid as a loss. A small price to pay for hedging!

Costs are incurred for each long put purchased. It is therefore generally It is not advisable to permanently hedge your shares in this way. Such a hedging method should instead for a short time, on suspicion of an imminent price slump, are used. 

4. protect your portfolio through hedging

The concept of the Hedgings is as simple as it is ingenious: Instead of hedging our shares, we offset potential losses with additional gains. To this end, we use positions that benefit in the event of a price decline. 

Here we have a Large selection available: 

• Through a Short sale the value of our position rises when the price falls. This allows us to generate returns with falling prices. 
• Some ETFs work inverselyThis means that if the price of the index they track falls, their price rises. 
• With Futures you can trade shares, commodities and other goods in the future. We can not only hedge against falling prices, but also the other way around profit from falling prices!
• The world of Options offers solutions for hedging. For example, we can use the aforementioned Long Put not only sell our shares; we choose a contract with "Cash Settlement" the difference is paid to us in cash instead, so that we benefit directly. 
• Also Certificates and warrants offer opportunities to make profits when prices fall. They have only limited risks, but in return come with performance disadvantages and an issuer risk. 

For all variants, the Use of levers possible. These amplify the price movements of an asset by a predefined factor. For example, a leverage of 10 would increase both profits and losses by a factor of ten. This makes it possible for traders, to hedge larger equity positions with less capital. 

Once again, however, the choice of broker is crucial: leveraged products - just like short selling and margin trading - are not available on the market. only fully available with top-class brokers such as CapTrader. Without access, the protection options for retailers remain severely limited. 

Conclusion: There are different ways to hedge shares

Gains in your equity portfolio are often hard-won and should not be wiped out by price setbacks! There are several ways to protect your investments. 

The basis for this is a Good diversification. If you divide your positions sensibly between sectors, regions, company sizes ... you can already hedge your shares well. However, it is not necessary to overdo it: From around 25 stocks in the portfolio, further purchases hardly result in any risk advantage. 

It is also It is strongly recommended to protect all securities at risk with a stop order, trailing stop-loss order or other order forms. These trigger a sale if the share price falls to a predefined level. As a result, the positions are sold and we do not have to participate in the downward trend. 

Active protection methods include, above all, the Hedging. In doing so, we positions that gain when our shares lose value. Various financial products such as futures, certificates, ETFs and more can be used for this purpose. Top-class brokers such as CapTrader also offer leverage that can optimize such hedging. 

Probably the most demanding option is the Options trading. It allows us to hedge our shares in several ways. One A simple long put is executed quickly and guarantees us the sale at our desired price but also costs a fee in return. This form of share hedging is therefore particularly suitable in the short term, if there is a concrete suspicion!