Stock Investing – When Should You Hedge Your Investments?

| February 14, 2011 | 0 Comments

I have a confession to make.  I’ve taken up a new hobby.  And it’s consumed my free time over the last few months.

The latest activity to capture my eye and my time is gardening.

Every month I pour over a number of gardening magazines.  I’m always looking for information, tips, and tricks to improve my skills.

While learning from books is fine, there’s no better teacher than real life. And I recently learned an important lesson first hand.

Unfortunately, it was a painful one.

Here’s the crazy part… my lesson doesn’t just apply to gardening.  It also applies to trading stocks as well.  Let me show you how…

Over the past year, I’ve created a small garden area on the side of my house.  I built raised beds for my vegetables.  I even tossed together a pretty sizable compost pile.  Believe me, with five horses there’s plenty of material to compost.

It’s a labor of love.

I enjoy being outside, working the earth.  I like the feel of the dirt on my hands and the sight of flourishing plants.  And when I work up a good sweat, I really feel like I’ve accomplished something meaningful.

My garden has slowly grown from one small four foot by four foot planter to several raised beds of over 150 square feet.  And I’m not done yet.  I’m planning on doubling the size of the garden later this year.

When I put my mind to something, I go all out.

Surprisingly, I haven’t had many problems.

The wildlife has kept their distance… that is until recently.

In Arizona, we have a number of critters.  Two of the most common are the cottontail rabbit and the jack rabbit.  These furry friends live to devour tasty plants and vegetables.

Up till now, these little critters have survived and thrived by eating the leftover grass and alfalfa from the horses.  They’d left my garden alone.

Little did I know these rascally rabbits were setting a trap.

One garden box was growing full steam.  Since I didn’t have rabbit problems, I built a second bed and didn’t bother to fence it.  Then I built a third.  The planting was perfect.  Within a few short weeks, my garden was looking lush and full.

I was dreaming about all the great vegetables I’d be able to pull from the ground and cook up.  My mouth was salivating at the coming bounty!

Then something strange happened…

While watering the garden one Friday afternoon, I noticed a few plants missing.  It looked like a little bunny decided to take a nibble.  It was only two small plants.  I made a mental note to fence the garden the next morning.

That’s when disaster struck.

I was up with the sun.  As I walked over to the garden, fencing materials in hand, I found only total destruction.

The unfenced planters were picked clean.  Four weeks of strong growth had been devoured in a matter of hours.  I stood there stunned.

Everything was gone.

Turnips, radishes, beets, peas, beans, carrots, the winter squash.  The entire garden was eaten down to the nub.  And I could only blame myself.

I’d seen the warning signs… but instead of taking action immediately to protect my garden, I waited.  And those few hours cost me dearly.  I started replanting almost immediately… but first I built a fence around the garden.

It was a painful lesson to learn.

This difficult lesson is one every stock trader needs to learn too.  Often the markets take off on a nice long run higher… that’s what we’ve seen for more than 18 months now.

Many investors have short memories.

They forget the market can fall as quickly as it climbs.

Many stayed fully invested in stocks during the market downturn in 2008. How many people watched as the market fell by 10%, then 20%, then 30%, and did nothing.

They witnessed firsthand the warning signs.

They could sense the trouble coming.  But instead of hedging their portfolios, they stood idly by and did nothing.  Instead of taking immediate action to protect their money… many investors suffered huge losses.

Remember, during the credit crisis, we didn’t just fall from 14,000 to 6,500 on the DOW overnight.  It took almost 14 months.  There were numerous opportunities to lock in gains and prevent bigger losses.

So why am I sharing these thoughts about hedging your portfolio?

Do I see something in the market that scares me?

NO.  The market is looking good to me… and I think it will continue moving higher over the next few months.  However, we must always be on the lookout.

Watch the market closely and look for the warning signs.

When you see them, don’t hesitate to act.  Protect your portfolio.  Hedge what you can and get out of the rest.  It’s the only sure way to sidestep another slide and conserve your capital.

If I had built the fence the day I saw the warning signs… I’d have a lush and fruitful garden.  And if more investors had taken immediate action, they could have sidestepped the market collapse in 2008.  Learn the lessons of an experienced gardener… and don’t let your portfolio get eaten!

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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