The ‘Black Swan’ is a market crash that comes out of nowhere and surprises even the experts. The drop in market indexes pulls down the value of 90% of even the strongest stocks. This event is like a a financial hurricane that causes major damage to any portfolios.
In 2006 the famed ‘Flash Crash’ was due to a chain reaction of trading triggers set in place by ‘quants’ or software experts who use complex algorithms to anticipate market movements and collect profits. Much of today’s high speed trading is driven not by human decisions allowed by a increasingly complex network of overlapping automated systems. For this reason it’s not always possible to anticipate what confluence of events can start the dominos falling.
So how can the average trader dare to open trades and leave themselves vulnerable to potentially devastating financial ruin?
One traditional solution has been to ‘diversify’ ones portfolio. This is the definition of a ‘hedge’. A hedge is a financial ‘shrubbery wall’ that encircles ones assets. The classic notion has been to always combine positions in a portfolio that are uncorrelated. A classic hedge has been the balance and opposing movement of stocks and bonds. Or in some periods in the past, between gold and stocks.
The problem with a simple balancing of a portfolio with positions that move opposite to each other is that your goal is to become a money market fund! At the end of the year the loss of half your stocks is balanced by the profits of the other half. One can see that having a long term goal of 0% growth per year will not grow your savings, although it could protect them.
The solution of fund managers is to regularly re-balance a portfolio. As some stock sectors are cyclically stronger, they are held until they weaken and are replaced with another sector stock whose cycle is strengthening.
The method which I have detailed in my free e-book is much simpler to manage. It uses a basic option spread in a special way to effectively provide a safety net for extreme market crashes. This allows the trader/investor to go about their business in only making the trades which they project will profit if the market continues without a crash. It’s similar to buying hurricane insurance. You hope you never need it! Compared to the protection provided, the cost is small. If setup correctly it can provide significant profit to offset any losses incurred in a major market decline.
Please download my e-book and consider if the method is appropriate for you.