Didn't know that my unlevered "trades" where not "trading".
Why hedge, why not just buy a smaller position?
- Thread starter IronFist
- Start date
Didn't know that my unlevered "trades" where not "trading".
Simple.
Size does not reduce risk. Hedging does.
Small size is supposed to save you from blowing up. But in reality small size only delays that risk of blowing up. So it never actually gets rid of that risk.
It only cuts that risk into small pieces. And those lots of small risks are still there waiting for you in your next positions.
Small size gives you lots of small losses. Big size gives you one big loss. There is no difference between them.
Size does not reduce risk. Hedging does.
Small size is supposed to save you from blowing up. But in reality small size only delays that risk of blowing up. So it never actually gets rid of that risk.
It only cuts that risk into small pieces. And those lots of small risks are still there waiting for you in your next positions.
Small size gives you lots of small losses. Big size gives you one big loss. There is no difference between them.
This is obviously not true. Reducing size reduces your risk since you can lose less on a single transaction. Assuming that your expected profit or loss are proportional to the size the trade, appropriate sizing will prevent you from blowing up. Hence the whole idea of risk-based sizing (Kelly or other).
Hedging, on the other hand, changes your exposure and is supposed to reduce your variance while keeping your alpha. That does not mean that you should not be controlling the size (a lot of people feel tempted by the reduction in variance to really load up), since hedging just removes exposure to specific factors but you are still carrying risk.
I think in simplest terms, us retail traders have a married put in mind, which is just too expensive. But in terms of reducing risk of ruin, you can play around with different spreads or you can buy a lower number of puts to comfortably adjust your risk. Options traders often use the terms "adjusting delta" or event going "delta neutral" to eliminate directional risk. If you do not like pain, definitely hedge.
Let me edit this thread as well, there are two following concepts to consider. One, you could view a hedge to make money on the downside, then if the security goes back to break even, you are ahead. Two, if you make less money but not less than zero, your P/L chart will incline upward. I have a zero month myself once in a while to pay for my hedges, over time I will come out ahead.
Let me edit this thread as well, there are two following concepts to consider. One, you could view a hedge to make money on the downside, then if the security goes back to break even, you are ahead. Two, if you make less money but not less than zero, your P/L chart will incline upward. I have a zero month myself once in a while to pay for my hedges, over time I will come out ahead.
Huh? I would think most use hedging not because they can't take a loss, its because they don't want to take the GAIN, and the tax that goes along with it. I'm in that boat - I would reduce certain positions today if I didn't have to recognize huge built in gains. But I don't want to. Hence hedge.
Yet when the market takes a bath, so do they. So then what all this hedging is good for? Because without it they would take an even bigger bath? That just means they are over leveraged, and we go back to the OP's question, why not just take a smaller position?
When investors want to isolate certain factors but does not want to general market exposure they need to hedge. For eg. investors want to get exposed to value factor, then they go long value stocks short the market beta. If they want to have some meaningful return, then they have do it in size.
Debating about whether to hedge is like debating whether to use the brakes on your car. 
