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Simple Short Exposure. This strategy effectively shorts the S&P 500 by buying shares in the S&P 500 Short ETF. Simple Hedging will assume that 100% of the backtest's invested principal is always in the backtest's long positions.

For example, if you choose a 25% hedging rate, then for a $10,000 portfolio, you will be long $10,000 and have a $2,500 short on the S&P 500. The short position will adjust each rebalancing period to match 25% of the total portfolio. Any gains/losses from the short are added to the overall available capital for the long positions in the portfolio.

Moving Average Hedge. With this strategy, your portfolio will be hedged by shorting the S&P 500 whenever your long portfolio's performance drops below the monthly moving average. So if you set a 25% hedge, 25% of your long portfolio will be sold and the funds reallocated to the short whenever the hedge is in effect. Once your long portfolio performance goes back over the moving average, the short hedge will be removed and the funds from the short will be reallocated to your long positions.

When hedging strategies are being used, backtests can only go back

as far as 2006. This is the date the S&P 500 Short ETF first appeared.

Pro subscription required to use hedging strategies

the moving average that will determine when hedging is on or off

You can optionally include a stock sell buffer in your backtesting model. It works by keeping a stock in your portfolio even when it would otherwise drop out during rebalancing as long as it remains within your sell buffer threshold. For example, you are backtesting with the top 20 stocks each quarter and set a sell buffer of 50. In the first quarter, AAPL is one of the top 20 stocks and is included in the portfolio. In quarter 2, AAPL drops down to number 25. Without the sell buffer, AAPL would drop out for that quarter, but since it is still within the sell buffer threshold of 50, it will remain in the portfolio. Your portfolio size remains the same. The stocks that would have fallen out stay in and the stocks that would otherwise have been added stay out. Using the sell buffer may help produce a lower turnover rate.

Category: Advisor

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