After the drop in the market this week, many must have realized that we should look at the starting point of this spectacular rally. It is scary. Such fright that comes into our minds every time we go into a few percentage points pull back after a big move can be combated with the help of few handy alterations.
Now at this price point in the market, we have a lot to lose. We have talked about the practice and prudence in hedging when the market is at its extreme.
However, in the case of pull backs in a rally that shakes the confidence a little bit yet keeps the conviction in the overall trend intact, we should keep trading with trend but with few alterations.
This alteration is to have a Conjoining trade along with the existing trade that is aimed just to improve your Risk: Reward profile. I wouldn’t necessarily call it a Hedge as it is always looked at as a mechanism just to stop from bleeding further.
This is because the trade alterations we are talking about is not only associated with restricting further losses but also at locking profits. A preconceived sequence of trades that keeps you in charge of the drawdown at all times.
Many would refrain from trading into a market like this where the potential winning and losing percentage are at a mismatch (Considering the possibility of a bigger pullback). So instead of stopping to trade take all the opportunities that you would have taken to trade just keep the alterations is mind.
Just like hedge though these Conjoining Trade Alterations would also
a. Always come at a cost which is irrecoverable
b. Would Alter future Cashflows rather than Past
Alteration #1: Let us say one already has a position in equity market (Cash, Futures or Options). The position starts incurring losses. Now many of us (including me at times) would not be willing to exit at our predefined level.
When it comes to taking that bit of extra more risk beyond calculation, create hedge.
Result: The position won’t bleed any further and we would still be in the around just in case the position turns favorable after hitting the stop loss.
Modification #2: This conjoining trade would occur when we are sitting on Profits right now. In that case instead of mulling over whether or not to book take a cost create an opposite position in option (Have Buy Future, Buy a Put) and sit on it keeping the upside open at the same time locking accrued profits.Modification #3: For every trade taken after realizing the commotion at the Top, have a big heart and create a trade at the beginning with a buy position in Put Option so that at the cost of that Premium, all we need is to just track profits, do not track losses.