The sooner you start to think of your overall portfolio instead of expectations of individual stocks (although you should think of that too) and start thinking in terms of probabilities of various outcomes, rather than trying to decide exactly where the stock is going, the sooner you can start increasing your profits.

My spreadsheet helps tremendously as long as you can determine a set of potential outcomes and the probabilities of them occurring.

Just to show you what a few “hedges” can do, I considered your average return per any possible outcome for a full strategy decreases 2% by hedging. The bankroll increase “per trade” on just ONE trade with these averages would drop from 1.32 to .84 or 63% of the full value (decrease of 37%). But you add 2 more trades, and it reduces your overall correlation from .70 to .30. What is the outcome per same period of time?

As a result of adding more trades at a lower correlation, it actually goes up.

Before hedging.

AFTER adding just 2 hedges:

Finally, 5 hedges, fully neutral, but with 5% decrease in every possible outcome.

The correlation is now zero, but the overall return has dropped to less than the return with 5 bets at a .70 correlation. This is because reducing your return, even with 10 bets at zero correlation is not worth it. You want some hedging, even if it decreases your “per bet return” as it will add to your overall portfolio return. However, you do not want too much hedging or “delta neutral”strategy if it decreases your return too much, even if doing so allows you to leverage multiple bets in excess. There is no “rule of thumb” to this, each trade is different. You could come up with a strategy where “full hedging” is better, as you could come up with a scenario where “no hedging” is better.

However, generally speaking some hedging is always good if it can provide a positive return and the hedge ALSO is negatively correlated with the rest of your portfolio.

So how does one find bets with a positive expected return with inverse correlation?

Most bets are done WITH the market. Bearish bets in a bear market, bullish in a bull market.

But, the bearish confirmation on a White Marubozu candlestick pattern results in a 3 day hold that yields expected returns of -2.81% in a bull market. Although it receives a -3.95% in a bear market, the -2.81% is still good.

The reverse is true, a bullish confirmation on a Black Marubozu candlestick pattern results in a 4.08% return in a bear market (which actually is better than the 3.86% in a bull market).

In A bull market, a bearish confirmation (breakdown) of the following patterns yield a below negative 2.50 per trade. As such, going short will return more than 2.5% over a 3 day period.

The patterns to HEDGE when in a bull market:

**Three White Soldiers**

**abandoned baby, bullish**

**morning star**

**Marubozzu, white**

**Doji, Dragonfly**

**piercing pattern**

**Engulfing Bullish**

The Patterns must break BELOW the lowest low of the pattern for bearish confirmation.

There are more bear market hedges. Some people prefer price patterns instead…

Also, there are Bullish bets that work in bear markets. We will get to those later.