The purpose of hedging is to allow investors to protect profit they have accumulated in their investment portfolio and still allow them to keep receiving dividend income from their shares and possibly option premiums they might be receiving as part of their option writing strategy they have incorporated into their portfolio management.
While you always have the option to sell your shares and take your profits, when doing so you may incur capital gains tax and lose the ability to keep receiving additional income from your shares like dividends and option premiums.
Shares held for more than 12 months qualify for 50% discount in capital gain tax, giving you another reason to hold your shares for the longer term.
Ideally, one would hedge shares that have produced a profit and offer additional income streams such as dividends, and only sell the shares that have not yet produced any profit for you or don’t have very high dividend yields. Having the knowledge to hedge simply allows another choice, rather than let a portfolio be at the whim of market changes.
Hedging Strategy for Individual Stocks:
This method is to hedge each share individually by either using Exchange Traded Options or short selling CFDs on each share in the portfolio that has accumulated a profit.
This is usually done as a neutral hedge which means that the hedge position has an equal value to the holding but could be done as a positive hedge for some profit potential. Another approach could be to sell half the holdings value position when the signal triggers, allowing you to lock in some profit and hedge the remainder of the original position.
An example of a technical signal to initiate the hedge occurs when the up-trend is broken on a weekly stock chart, suggesting a potential peak and a selling zone.
A confirmation could occur when further technical indicators show selling pressure, and the price shows a start of a down trend.
To effect a hedge, a derivatives trading account is utilized with access to CFDs for short selling and hedging purposes, or the Strategy can also be taken using Exchange Traded Options.
It is advised to attend training sessions on both of these products before executing a hedge strategy.
When to Close Out the Hedge:
A hedge is normally closed when an individual share starts to rally and breaks up through their down trend lines and technical indicators show evidence of buying pressure.