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Does it make sense for most portfolios to have some short position? Is there a general rule (maybe a minimum of 10% should be hedged by a short position for high growth portfolios if you have a positive outlook, 100% if you have a negative outlook, or maybe ~50% should be hedged if you want an income generating stable portfolio, etc.?)

As equities continue to be the winners in the market, it seems dangerous to not hedge an equity position, but I am not sure if there is a good general rule.

  • It's a great idea if you can time the market (i.e. forecast whether the next move will be up or down). Unfortunately that's a big if! – assylias Apr 30 '15 at 12:08
  • Are you asking only about corporate stocks? Because there are plenty of ETFs that are entirely composed of short positions, so shorting on those ETFs is the same thing as being long in the underlying. – dg99 May 1 '15 at 23:28
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note: here I use the convention: short term: < 1 year short long term: 1-10 years long long term: 10 years +

Even if you are positive in the "Long Long" term it may not work out that way in the short long term (yes, yes I know) and so you hedge against short term losses due to volatility etc. with short positions (usually options). Short term losses include crashes and corrections and so in the short long run (a crash is long run for traders, short run for investors) you can profit from both being long and short as you profit from the fall in the short long run (the crash and following depression/recession) and from the long position in the long long run when prices recover. Long long term short positions are there to cover the possibility that the company makes poor decisions or goes bankrupt (or a few other things) and the stock falls to a sustained low.

The exact proportion of long positions to cover with short positions is a difficult calculation and there are many long books devoted to "portfolio theory" covering the intricate maths behind it. In short the short positions of a portfolio should be enough to cover any short term volatility in the stock price (measured by historic volatility plus a little bit of statistical projection). There is not and cannot be any general good rule for this; a very volatile stock will need a much larger hedge than a less volatile stock. Long long term hedging is related to the probability of default of the company and results in small short hedges.

  • What is short long term, why not just use medium term! – user9822 Apr 29 '15 at 4:00
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    Because we divide investors into short and long term with short being the day trader type investors and long being people who hold for longer than a trading period. Just a convention internal to my work place and a few hedgies we work with AFAIK – MD-Tech Apr 29 '15 at 7:08
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    Well once again why not use medium term? By the way short term would not only refer to day traders but also position traders and swing traders who may be in a trade from one day to a couple of weeks. Medium term would refer to a trend trader or range trader who would be in a position from a few weeks to one or two years. And a long term trader/investor would be someone holding a position for more than two years. – user9822 Apr 29 '15 at 21:16
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    Because its our convention. You can call it whatever you like but that's our internal term. That's why I defined it! – MD-Tech Apr 29 '15 at 22:48

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