Traders Don't Need No Stinkin' Hedges

When the market starts to struggle, market players often struggle with the decision between putting on a hedge or simply selling and going to cash. The best approach depends to a great extent on what sort of stocks you are holding and your investing style, but typically the small individual investor is better off holding cash rather than hedging, especially if you hold more volatile small-caps.

Institutions and hedge fund players often hedge simply because they don't have the flexibility to move in and out of individual longs that easily. It is much easier to short and cover the SPY or the QQQQ than it is to sell down and re-buy an individual stock.

Individual market investors usually don't have that problem. They can sell and re-buy their favorites without much of a problem. Also, if you tend to hold smaller, more volatile stocks, they are likely to fall faster than your hedge will rise unless you are hedging at 2 or 3 times your long positions. Hedges can give you a false sense of comfort at times if you have a lot of high-beta or thinly traded small-caps.

If you hold slower-moving big-caps you can hedge much more easily, but usually the small investor is better off sitting in heavy cash. You can always jump back in without too much trouble so the hedge has limited value as far as keeping you flexible if you are smaller trader. ...