The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

Trader Risk Profiling and Position Analysis

26.10 Hedging Positions with Derivatives

To hedge means to neutralize some or all directional risk associated with a posi-

tion or portfolio. Traders and investors may mitigate or eliminate risk by fully or

partially hedging a position or portfolio in the market.

Hedging can be done via the use of:

■ (^) Equal and opposite positions in the market for a fully hedged position
(e.g., hedging one long position with an equally sized short position);
■ (^) Unequal opposite positions in the market for a partially hedged position (e.g.,
hedging two long positions with a single short position);
■ (^) Long and short call or put options based on the underlying stock or traded
instrument;
■ (^) Long and short futures contracts based on the underlying stock or traded
instrument; and
■ (^) Long and short a funds or ETFs/ETNs that track the underlying stock or
traded instruments
When hedging with derivatives, it is very important to ensure that the tick
values, contract limitations, and trading costs are fully accounted for in order for
the hedge to work properly.

26.11 Chapter Summary

As we have seen, we may categorize market partipants via their particular risk

profiles. We also observed how these profiles relate to various choices with respect

to order entry. In addition, we learned how a trader may be both conservative

and aggressive at the same, with respect to time of entry and price on entry. There

were situations where a trader could also be fully aggressive or conservative. It

is always imperative that the practitioner understands his or her clients’ risk and

behavior profiles in order to better advise them with regard to appropriate invest-

ment recommendations and decisions.

Chapter 26 Review Questions

1. Explain why client profiling is not merely about understanding their psycho-
   logical makeup.


2. Describe why it may be difficult to exit all positions on behalf of your client.


3. Describe ways in which you would help your client understand that losses
   resulting from following a trading plan are justifiable.


4. Explain how you would use overreactions in the market to alter your overall
   capital exposure.


5. How much information about the daily management of a client’s position
   should be made known to the client? Where would you draw the line?


6. “For every bullish or bearish signal or indication, there exists an equal and
   opposite interpretation of that signal or indication.” Discuss with examples.