Hedging – Step By Step

Hey it’s Pete. How’s it going? In this video we’re going to talk about something that is kind of a mystery to a lot of traders but can add a tremendous amount to your bottom line and significantly reduce your stress level, which is obviously something that we’d all love in trading right? Which is the subject of hedging your portfolio and hedging your active trades. Enjoy this video and leave a comment below if you have any questions. I’d love to follow up with you. Have a great day! 

Getting a little bit of weakness in certain sectors, obviously the FOMC and quadruple witching on Friday. Do you mind talking about hedging strategies? The best way to counterbalance a market that’s fading as a new trader? What are the signals? 

So there’s…we’re not going to get into too much on this because I think what we’ll do is we’ll turn this into a whole other video just dedicated exclusively to hedging. But I will tell you, actually remember the picture that I posted this morning, the picture of the guy that I used to trade with, that took that has the picture of him and Tom Brady this weekend. He was by far the the the best hedger/multi-sided trader I’ve ever seen in my life and like I just said, the guy made a fortune. He averaged three to five million dollars a year, mostly day trading by the way, mostly day trading. I would say 70% day trading, 30% swing trading. And essentially what he would do is that if it was a bull market, he would trade three to one long. So in other words, for every three shares he had long, he would have a hundred short. 

So what he would do is let’s say he would buy 300 shares – and I’m just using these numbers just for illustrative purposes – while the market was bullish, anticipating the fact that they were going to be pullbacks. He would also short, and I want to be clear about this, weak stocks, 100 shares. So his entire strategy was recognizing relative strength and relative weakness. 

So he would have a list of stocks, similar to what I have on my daily game plan, in this one. So this is the one that I have every day that I’m watching during the day. So this is the list of longs – they’re above the opening price. Then I have my list of shorts, which is on the opposite side of that, where let’s say for the week and the current hour, which on this here is 60 minutes. So that would be below and below. So it would be negative 1 and negative 0.10. So this would be the list of stocks that were weak. This would be the list of stocks that were bullish right now. We’re actually on the opposite right now, the way the market traded today! 

But I just want to make this super clear: he would not be shorting strong stocks. He’d be finding weak stocks exactly the way I just said. He’d be buying aggressively and adding to his long shares on a three to one ratio when the market went up. He’d be buying more, having this small short position as it started to peter out. He’d get out of his longs, he’d add to his shorts, make money on the way down because he was already reading the tape in those weaker stocks as it went down and he’d start the process all over again. 

He was long and short all day long. Short weak stocks in a bullish market, short weak stocks – not short strong stocks – very important, less shares on the short side even though the stocks were weak. When the market rolled over, he’d make money on the shorts. When the market caught a bid again, he’d start building the long position and do that all day, every day. That’s in a bullish market.

In a neutral market, which we could very likely be in very shortly, in a neutral market he’d be aggressively long and short both sides of the market because there was no bias to the bigger picture. That’s probably the easiest way I can explain that. But I will tell you this: watching an experienced trader do this is an absolute thing of beauty, an absolute thing of beauty. Because when you go back to what we talked about today at the beginning of the call, talking about reading the tape, talking about reading the order flow. 

So you have the order flow on the monthly and the weekly, you’re reading the tape on the daily charts – is it a buy day, a sell day, a sell short day? You are literally coming into the day fully scripted, knowing which side of the market you want to be on, which side of the market you want to be heavy on. And you are now, in any way – and this is not an exaggeration, I swear, because I’ve done it – you’re in anywhere from 5 to 15 positions at the same time. Not exaggerating, even dial that back all the way back. Let’s say you’re in two long positions and one short position. That’s manageable for anybody. 

When you when you when you when you when you trade what the tape is offering and trade the share size in the context of the current bias, it’s literally a thing of beauty. I don’t know if I could say it any other way. You are literally dancing with the market back and forth with the right share size at the right time. The market’s going up, you’re exiting your longs and you’re putting on shorts because those stocks are already weak. If the market reverses and you see that in the VIX and the ticks, now you start building your short position. You wait for it to go down, you cover your short position, you start building it long again in this bullish environment. It’s a thing of beauty. 

I can’t, I’m using like flowery language. It’s a freaking thing of beauty when you are that in tune with the market. You when you are that in tune with the market you literally don’t even know what time it is. There have been so many days where the market finished, when you are just so in a zone, bell rings at the end of the day and you’re like “Oh my god, it’s 4 o’clock already?” You don’t even know what time it is. You are so zoned in on every wiggle and jiggle, uptick and downtick, and working those positions. It’s, it’s, it’s just, it’s beautiful. I can’t even say it any other way. That is trading at the highest levels. 

That’s where our community will eventually get to. The reason we have not done this, quite frankly, why would we? The market was a raging bull market fueled by quantitative easing for 18 months. Why in the world would we be looking at short sales when the bullish side of the market was a gift from the trading universe? We’re getting a little bit more into a different tape, as I’ve been talking about for about a week and a half. 

I would love to see some feedback on trading three positions of 100 shares from members of our community. I think that you will be shocked at how different trading is without being overwhelmed by the positive and negative emotions of trading too big. I think you will be shocked at how less stressful it is. And I think you will be shocked at how reliable your P&L is because five positions, three work out, two don’t do anything, maybe one’s a loss. You’ll be surprised: 100 shares over three different trades – if three positions of a hundred shares move a dollar, a dollar fifty, you’re up four hundred and fifty dollars on a hundred shares. The other two trades maybe you lose 100. Now you’re up 350 for the day without hardly any stress. Take that to the bank because I’ve experienced it personally. I take it, I’m telling you, take it to the bank. I would not suggest that if I didn’t go through it myself. 

Aldo, I promise that you and I and sorry and everybody will have some we’ll have some deeper conversations on how to plan this into a bigger call. But even if we’re talking about hedging the portfolio, you could use that same process by first determining what is the longer what is the larger bias in the tape, and then how does that translate into that three to one context.