Following Up on Hedging Strategies

Although six of the 15 stocks continued to move lower, those that rebounded flew. Sprint(S) more than doubled. First Solar was up nearly 80%. MetroPCS Communications'(PCS) stock price is more than 60% higher than it was just eight weeks ago. This portfolio strategy may have value for nervous investors who are looking for hedged exposure to an uncertain market. It's early in the test, but I will be carefully watching developments in this portfolio.

It is also instructive to look at the stocks without a hedge. Traders may want to start focusing more on stocks in the index that are falling knives with large 52-week losses instead of the momentum darlings. These issues have rebounded sharply, rising far more than the broad market.

In today's low-volume, short-term-trading-dominated market, once the fundamental sellers such as mutual funds and institutional asset managers are done exiting the stock, there are few natural sellers left. When the index buyers and traders move into the long side of the market, the buying pressure in the absence of sellers causes short-covering and spectacular rallies. With no fundamental selling taking place, these issues should track the market or even outperform slightly on the downside.

A reduction in the number of natural sellers and an absence of retail investors means that losing stocks may revert to the mean much faster than years past. At least that's the theory, and I plan to continue tracking the results of these portfolios. Hedged mechanical portfolios are not part of my regular activities, but this is a fascinating subject. In addition, I suspect there is valuable information to be garnered by tracking and testing these ideas.