Hedging your trade is equally important as trading. While picking up a stock it is important that you think of an instrument that can potentially withstand the risk your invested-in security might be posing.
In technical terms, Hedging means taking a position in an instrument which can averse risk you have your investment in. Be sure that the hedged instrument should have negative correlation with the instrument have invested in.
In layman terms, Hedging plays the same role for investment as life insurance does to your health and life.
In my view there are three ways through which you can hedge your instrument. The way should be chosen by you as per your risk capacity.
The first instrument can out-rightly hedge your entire holdings is Gold. Although the exact correlation of gold to the stock markets is not known investors have a perspective that gold usually moves opposite to the stock market. During an immediate market crash, gold is the only tradable instrument that offers safe haven to investors.
Moreover, gold usually has a defined range within which it moves. For ex- since 2014 the range of Gold is Rs 26,000 – Rs 34,000 per 10 grams. This makes it simple for investors to place trades.
For small traders and investors hedging index or stock options is the best way to hedge. It does not matter if you have held equity or Futures; you can hedge your positions by buying options with a strike price opposite to the expected trend. Obviously, take positions in only those options which have high Open Interest and High Volumes.
However, make sure that those options are not with you throughout the month because option prices erodes with time. Be sure to exit it within 3-4 days.
In past few years, Indian stock markets have seen cyclical investments. This means that while buying is going on in one sector, the other sector may be witnessing a sell-off. So while you take a Long position in one security that is seeing a buying interest; take a Short position in other security that is seeing a sell-off. This way your trades will be protected and you can earn both sides.