The global market has recently been shaken by Trump's announcement of a reciprocal tariff policy, causing sharp declines in major U.S. stock indexes. Such unpredictable events underscore the importance of understanding market risk and employing effective hedging strategies to protect investment portfolios. In this article, we’ll explore what market risk entails and provide actionable strategies to mitigate losses during periods of market turbulence.
1. Diversification
- Spread investments across different asset classes (stocks, bonds, commodities, real estate) and geographic regions to reduce exposure to a single market's volatility.
- Avoid over-concentration in industries or sectors directly impacted by policy changes (e.g., trade-sensitive industries during tariff announcements).
2. Asset Allocation Adjustments
1）Allocating to Safe-Haven Assets
During periods of heightened uncertainty or market turbulence, shifting portfolio allocations toward defensive assets can help preserve capital and reduce volatility:
- Gold: Historically viewed as a store of value, gold tends to perform well during economic or geopolitical uncertainty. Investors can gain exposure through physical gold, gold ETFs (e.g., SPDR Gold Shares - GLD), or gold mining stocks.
- Treasury Bonds: U.S. Treasury bonds are considered one of the safest investments due to their government backing. Long-term bonds (e.g., 10-year Treasury notes) often rise in value when investors flee riskier assets. Treasury bond ETFs, such as iShares 20+ Year Treasury Bond ETF (TLT), offer an easy way to gain exposure.
- Cash: Increasing cash holdings provides liquidity and flexibility to take advantage of investment opportunities during market corrections while minimizing exposure to volatile assets.
2）Increasing Exposure to Low-Volatility or Dividend-Paying Stocks
Certain sectors and types of stocks tend to perform better in turbulent markets due to their stable earnings and defensive characteristics:
- Consumer Staples Sector: Companies in this sector produce essential goods like food, beverages, and household products, which remain in demand regardless of economic conditions.
- Utilities Sector: Utility companies provide essential services like electricity, water, and gas, making their revenue streams relatively stable.
- Healthcare Sector: Healthcare companies benefit from consistent demand for medical products and services.
- Dividend-Paying Stocks: Focus on companies with a strong history of paying and growing dividends. These stocks not only provide income but also tend to be more resilient during market downturns.
It should be noted that in extreme situations, a liquidity crisis may occur. A liquidity crisis refers to a sudden shortage of available funds in the market, making it difficult for investors to quickly and easily convert assets into cash. It's like a reservoir suddenly running dry, with everyone desperately needing water but finding none available. During a liquidity crisis, investors rush to sell assets for cash, but with few buyers, asset prices plummet.
For example, during the 2020 COVID crisis: In the early stages of the pandemic, panic spread causing investors to rush to sell assets for cash. Even traditional safe-haven assets like gold and bonds experienced declines, as people needed cash to deal with uncertainty. Stocks, real estate, commodities, and cryptocurrencies - almost all assets dropped significantly in the short term.
Therefore, during extreme market conditions, derivative products and inverse ETFs can also be considered as investment options.
3. Use of Hedging Instruments
Options Contracts
Options are powerful tools for hedging against declines in stock prices or indexes, helping to minimize the impact of short-term corrections in asset values. Investors with long stock positions can employ strategies such as buying put options, establishing collars, or using index options to protect their portfolios:
- Buying Put Options: A put option provides the right to sell a stock at a predetermined price (strike price) within a specified timeframe. This strategy effectively locks in a minimum selling price below the current stock price, offering downside protection during market volatility.
- Establishing Collars: A collar combines a long put and a short call option. The put option sets a lower price limit (protecting against declines), while the short call generates income by setting an upper price target at which the investor is willing to sell the stock. This approach is cost-effective and ideal for traders seeking both protection and profit within a defined range.
- Using Index Options (e.g., SPX): Index options, such as SPX (S&P 500 Index options), are an effective way to hedge against broader market declines. These options are cash-settled and track the performance of major indexes rather than individual stocks, making them ideal for investors with diversified portfolios or exposure to market-wide risk. Buying SPX put options allows traders to protect against declines in the S&P 500, ensuring coverage for a wide range of assets correlated with the index.
During periods of market volatility and sharp declines, investors should use strategies like diversification, hedging instruments, defensive sectors, or dynamic asset allocation, tailored to their risk tolerance and goals. Staying calm and rational is key, as every downturn can present opportunities. With strategic planning and discipline, resilience in challenging markets is achievable.
