Don't Forget to Hedge Your Bets

I read with great interest yesterday's article by Doug Kass, which suggested that only the most nimble and astute traders should be on the field. To some degree, I agree with him. The economic conditions and uncertainty do not bode well for stock market performance in the months ahead. The tremendous wealth-destruction is going to create psychological aversion to the stock market for a long time to come.

I have said all year that most investors should be, for the most part, out of the market and tip-toe into any positions. I have seen a lot of people try to take advantage of the volatility and give up on investing in favor of trading, with disastrous results. Everyone who has asked me about trading the whips and dips has been given the same advice: Ignore the fancy charts and pay attention to some of the RealMoney contributors who have proven themselves. Trading is hard, and there are not too many who are truly good at it. Pay attention to those who have done it and made money. It is not my strong suit.

At the same time, for those of us who are aggressive investors, opportunities are being created that are difficult to ignore. The number of good companies selling at distressed company prices is getting longer every day. The problem, of course, is that the cheap just get cheaper every day.

To my mind, there is only one way to approach this market, no matter how aggressive you are or how good a value a particular stock may seem to be: You must be hedged.

There are a lot of ways to achieve this.

One simple way is just to buy a dollar's worth of an inverse ETF for every dollar's worth of stock you buy. If your stock picks go down less than the overall market, you end up making money on the deal. If it just keeps you in the game without the large losses we seem to see daily, then maybe you get to stick around until the recovery happens. That is a quick and easy way to hedge a portfolio of cheap stocks.

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At the time of publication, Melvin had no positions in the stocks mentioned, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.