When investing in a wholly unpredictable market such as the financial markets, you need to be prepared for any outcome with a loss being one of them. Injuries are easy to come by considering the volatile state of this market, which is featured by price fluctuations.
No trader expects a loss when investing in this sector. To curb these unwanted occurrences, some strategies act as insurance policies in trading. The insurance policy does not imply the real insurance covers provided by insuring companies. Instead, they are methods that you can opt for to reduce the impact of the loss or retain your capital level.
The Concept Of Having This Insurance-Hedging
The concept of insurance is like paying for both sides in a trade execution to prevent an unforeseen event. This strategy is evident in hedging, where you take an offsetting position in related securities. In this case, you can enter the market with the purchase of an asset hoping that its price will appreciate at the end of the trading period and sell it at a profit. Conversely, you have a speculation that this execution may result in losses if the price drops during the same financial period.
To shield yourself from this loss, you take a hedge by going short on the asset and short-selling it or even spread betting on its price drop. Whatever happens in the market, you will have yourself at the same level capital-wise at the end of the period.
A perfect hedge eliminates 100% of the associated risk and is inversely correlated to the security in question. In this case, if the initially opened position would lead to a loss of $100, the inverse position would earn you $100 hence returning you to your initial position.
Worthiness Of The Hedging Insurance Strategy
The hedging insurance strategy leads to no gains in the market instead of maintaining your capital level. Most of the experienced traders who opt for hedging do it to neutralize a mistakenly placed trade. If you choose this strategy, you remain constant in the market where there are no gains and no losses.
As a trader seeking to grow your investment in the trading markets, this is not a prudent move as there are no gains at all. You spend time avoiding risks. A beginner can use this strategy to learn how to execute trades without making a loss, more so by the perfect hedge. You can also use it to test a plan though it would be prudent to try out these functions on the demo trading account.
Another way you can hedge a position is by going derivative trading on it, speculating on a future price movement. This is common in forex, commodity, and share dealing.
The Stop-Loss Order
The stop-loss order is another tool that you can opt for to limit your losses. It does not operate as a valid insurance policy plan but qualifies as one courtesy of it restrict your losses in the market, leaving you with some of your funds after opening an unfavorable position. It functions where your broker, on your orders, automatically opts out of a losing trade when a price drops reach a certain level. This is a good strategy to opt for a sit also gives you a hint of positions to avoid and which are The Best to bank on.
Conclusion
Losses in the financial markets are a common occurrence through their effect may be pronounced to some traders and can even discourage them from trading activities. To curb you from losses, there are two insurance policies you can opt for, hedging and the stop-loss order. They are not specific insurance policies through their mode of loss prevention activities in the same way.
Hedging acts in offsetting an unfavorable position opened in the market, and a perfect hedge results in 100% rejuvenation from the loss. The stop-loss order, on the other hand, puts a limit on your losses should you incur any.
