At this point, the analysis was solid. Right or wrong, I had laid out a plan of attack and entered accordingly. Initially, the plan worked: The S&P started to rise, and I maintained all of my recent gains despite shorts that were now moving against me. Nothing much was changing with my underlying positions as they were not being stopped out, but simply moving within their respective ranges. The hedge was doing precisely what it was supposed to do.

At this very moment I made my mistake -- turning a hedge into a trade. Whenever I enter a hedge, my goal is to let my individual stocks dictate what I do with the hedge. Whether the hedge is protecting shorts or longs makes no difference. Once the hedge is committed, it's committed, and my next step is to adjust the hedge when the individual positions either stop out or start hitting profit-limit orders.

Unfortunately, I didn't follow this plan, and -- rather than letting the hedge play out -- I started booking the hedge gains as the market moved accordingly. Then, when I felt the coast was clear, I took it off completely and paid the price of an unnecessary draw of around 1%.

In my opinion, the proper way to handle a hedge is to allow the underlying stocks to determine what you do with the hedge. For example, if you're 50% long and feel a hedge is necessary, you may enter a 50% short. Theoretically, this negates your portfolio risk and locks in any returns you have. (I stress the word "theoretically," because rarely will a 1-1 hedge negate portfolio risk completely.)

As time goes on, and the market correction begins, you may stop out of half of your longs, taking your portfolio down to 25% long. Now your hedge is disproportionate to your longs and mandates you reduce your hedge by half, thus keeping your ratio in line with your original intent. As time goes on, you may be stopped out of all of your longs, thus covering the remainder of your hedge.

The trick is to not let the hedge turn into a trade, which is what I did on my last SPY hedge -- and what ultimately cost me. I've studied the journal, recognized the error and am ready to improve going forward. The greatest thing about the markets is the new opportunities we receive every single day.

Game on!

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