Best Hedging Strategy for Technology Investors

  • Matt Hagemann
    Matt Hagemann

    Portfolio Manager

Portfolio hedging is an underrated skill. It’s a superpower few investors possess. Those who do will outperform spectacularly during both bull and bear markets.

When the Nasdaq-100 crashes and goes into a downtrend, most technology investors don’t know better but to hold and hope that it will recover. Few know how to protect profits during a correction.

It doesn’t make sense to liquidate the entire portfolio. As an investor, you have analyzed stocks carefully before buying them, so it often makes sense to ride out a correction in the short term. The correction could be short-lived or a false alarm.

What you need is a cushion that dampens the impact during a market correction. The best way to hedge a tech-heavy portfolio is with the E-mini Nasdaq-100 (NQ), or with the Micro E-mini Nasdaq-100 (MNQ) for smaller portfolios. Both are futures contracts on the Nasdaq-100 index.

Futures contracts are the most cost-efficient way to get direct exposure to the underlying index because they are traded on margin. You only need to deposit a minor percentage of the notional value that you want to protect. Margins vary among brokers but they tend to be around 6% of a contract’s notional value. You also won’t get charged any interest fees for holding contracts over longer periods.

How to Hedge Technology Stocks

Let’s say that you hold stocks worth $100,000. When the Nasdaq-100 begins to crash, you sell short 3 MNQ contracts. They would hedge almost your entire portfolio.

Here is why: The MNQ has a multiplier of $2. You take the Nasdaq-100 and multiply it by $2 to determine the contract’s notional value. Since the Nasdaq-100 currently stands at 15,000, one MNQ’s notional value is $30,000.

Larger portfolios can be hedged with the NQ which has a multiplier of $20.

In practice, most tech-heavy portfolios need to be hedged with a little more than what they are worth because technology stocks tend to be more volatile. If the market crashes, your stocks often drop faster than the broader index. Your hedge can’t keep up which is why we need to find a way to bridge that gap.

A stock’s volatility is generally expressed with its beta. Beta describes the activity of a stock’s return as it responds to swings in the broader market. You can look it up for each stock.

  • A beta of 1 means that the stock swings exactly like the broader market.
  • A beta less than 1 or more than 1 suggests that it’s less volatile than the broader market or more volatile, respectively.
  • A negative beta means that the stock moves inverse to the market, but is rarely observed because stocks are a strongly correlated asset class.

To know how many contracts you effectively need to sell short during a market crash, you have to calculate your portfolio’s beta.

How to Calculate Your Portfolio Beta

To keep things simple, let’s assume that the above portfolio holds three tech companies equally weighted: Apple, Facebook, and Tesla. Next, you look up the beta for each stock and calculate the average portfolio beta:

CompanyBeta (as of August 2021)

The arithmetic average for all three betas is 1.48. What this means is that the portfolio swings 50% stronger than the broader market.

As a consequence, you have to sell short 5 contracts to effectively hedge your portfolio during a market crash. 5 MNQ contracts are a $150,000 notional value (50% more than our sample portfolio).

The Portfolio That Never Noses

The best way to hedge your portfolio is by following our short signals. Technology investors come to us because they want to know when they need to put on a hedge to protect their portfolio before a market crash.

Another advantage of trading the E-mini Nasdaq-100 is their daily settlement. As the market moves lower, your short position will build up a surplus cash balance that you can deploy back into stocks at market lows as soon as our system turns back bullish.

You have thereby established a portfolio that never loses.

This is a powerful concept because you completely remove inaccurate market timing and can make rational and systematic decisions with the help of our long and short signals. Our trading signals remove uncertainties. Technology investors, among others, see tremendous value in them because it gives them a good night’s rest.

If you also want to trade stress-free, you should definitely check out our pricing page.

Copying our trading signals is easy. We send you live notifications for when to buy or sell the E-mini Nasdaq-100. Write to us if you want to know more about out how NQ Signal could solve your trading challenges.

Author Bio
Matt Hagemann
Matt Hagemann

Portfolio Manager

Matt is the founder of NQ Signal. As a former Securities Analyst, he was bored juggling with Excel sheets and secretly reverse-engineered when the “big boys” buy and sell. Now anyone can succeed financially with the trading signals shared here.

Published August 28th 2021

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