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Today's Featured Article
The Current Market
The U.S. is presently amidst the most devastating fiscal crisis that we have seen since the great depression. The recent downward spiral in the stock market has shattered investor confidence, and has left portfolios at only fractions of what they were before. The current secular bear market has decimated the past five years of previous gains and has caused one of the most significant annihilations of wealth in modern history. Practically every major asset class and investment suffered record losses in 2008. The 2008 trading year left all of the major stock indices in double-digit losses. The NASDAQ Composite Index, which consists of more than 4,000 US and worldwide securities, settled
down 40.54 percent for 2008. The S&P 500 index is compiled of 500 large cap stocks that are considered to be widely held and whose performance is thought to be representative of the stock market as a whole. The S&P 500 index was 37 percent lower for the 2008 trading year. In addition, the Dow Jones Industrial Average Index which is comprised of the 30 largest and most widely held public companies in the US, settled down 33.84 percent for the year of 2008. Many analysts believe that the current volatility in Wall Street won't subside until strong investor confidence is restored. We believe that the recent declines we have seen in equities are likely not the bottom and we believe we are
bound to experience another leg down later in the year. Numerous investors are holding losing equity positions in hopes that the markets will turn around. However, investors are taking action and looking for ways to reduce market exposure, hedge off risk in their portfolios, and protect themselves from more significant losses. The one certain thing about stocks now is that they are uncertain. Investors could potentially help to protect an equity position by hedging it with futures. However, trading futures and options involves substantial risk of loss and is not suitable for all investors.
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Hedging Off Risk
Some analysts believe the current secular bear market actually began in 2000 and that it could last until 2020. The common thought is that the significant rallies within this time have been bear market rallies. Regardless of differing opinions, most investors and market analysts agree that the market is in a downward trend. The market is in a secular bear market now and most investors have no protection to the downside in place. "I think people are at a loss for answers right now," stated Larry Glazer, a managing director at Mayflower Advisors. "Investors are mentally exhausted, and the market at multiyear lows has a psychological impact." He continued by stating that, "It's possible
that the declines are part of a cycle the market needs to go through to get to healthier footing, but that, regardless of that, it's very painful for investors in the near term." Robert Loest, a portfolio manager at Integrity Funds stated, "The recent declines are likely not the bottom, with equities bound to experience another leg down later in the year. If you have a time horizon of 3 or 4 years or more, you're going to see good results, but this year will be grim." There are numerous opportunities investors have to protect an equity portfolio in a declining market. Investors can choose to pull out of the market entirely and lock in a loss, which hinders them from making back any money
in the markets. For investors looking to hold equity investments in today's declining market there are ways to hedge off risk in the overall portfolio. One of the particular strategies is to use stock index futures as a hedge, which can protect portfolios in a declining market. It is important to recognize the risks associated with trading options on index futures before you would allocate such an investment to your investment portfolio. Typical equity accounts these days do not have the ability to protect against a declining market, or have no protection in place. In addition, common equity accounts do not have the ability to trade S&P futures.
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Moving Forward
Now that we have examined potential ways to hedge off risk in today's market, the next step is to get involved. It seems like the majority of market analysts concur that the market is in a downward trend. A portfolio manager, Robert Loest of Integrity Funds declared, "This is a risky market and investors need to ask themselves if the stocks they own are ones they want to own through an extended downturn." William Dwyer, a senior investment office at Baltimore-based MTB Investment Advisors Inc., which oversees $24 billion stated, "Skepticism reigns supreme right now, I don't see any sustained recovery in the near term. We haven't even cleared out the bad asset on the financial side."
Making the decision to put a hedge in place is the first step. A senior account executive can perform an in-depth portfolio analysis to help determine the most appropriate hedging strategy. The total exposure currently invested in equities can indicate how much capital should be allocated to a hedge on the portfolio. Aside from the S&P futures index, there are numerous other futures sectors that investors can utilize to put a hedge in place. As an example, if an investor's portfolio is heavily weighted in energy stocks, a hedge can be placed using energy futures. With portfolio analysis it can be determined which sectors would be most advantageous to put into place. Please note that the
leverage provided by options can work against you as well as for you. Trading futures and options involves substantial risk of loss and is not suitable for all investors, and it is possible to lose more than the original investment. I suggest that any investor carefully considers the risk involved with futures and options trading before allocating any funds to this type of investment. There can be additional leverage provided in futures trading, so I recommend that all funds allocated to this type of investment are purely risk capital. I believe that we will continue within the current bear market for some time. The fundamentals sustaining further downside pressure in stocks are
substantial. If you have any capital invested in the stock market -- if you have capital on the sidelines -- or if you are looking to recoup some of the losses that your equity portfolio has recently seen -- I advocate hedging a small portion of your portfolio into the stock indices.
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About the Author
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Since entering the commodities industry in the late 90's, Mitch Fee has excelled as a broker and as a trader. He has built a name for himself as a hard working, disciplined, and passionate trader. Mr. Fee believes the key to successful trading comes from excellent risk management skills and an unwavering dedication to the trading plan.
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