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As investors we crave a specific plan of attack for every conceivable market scenario
so here are five alternative courses of action (other than cash) to consider in the current market. (Yes, it’s possible to put the market volatility to work for us.)
So writes Louis Basenese (www.wallstreetdaily.com) in edited excerpts from his original article* entitled The Five Smartest Responses to the Stock Market Selloff.
[The following article is presented by Lorimer Wilson, editor of www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Basenese goes on to say in further edited excerpts:
I shared yesterday [Don’t Bail Out of Stocks & Pile Into Cash – Here’s Why] with you that retreating into cash can’t be our default setting as it doesn’t protect wealth; it destroys it. Below are five alternative courses of action (other than cash) to consider in the current market. I’ll start with the easiest to implement and progress to a couple of more involved (but opportunistic) strategies.
~Volatility Buster #1: Trim it Up
Emotional responses always undermine our profitability. We either sell too early, missing out on more profits, or we sell too late, making it that much harder to recover from our losses. That means in all market conditions, we need to be robotic or, more plainly, we need to take emotions out of the equation.
The best way to take emotions out of the equation – to maximize profits and simultaneously minimize losses – is to use trailing stops. As a general rule of thumb, I use a 25% trailing stop on larger-cap, more liquid investments. For smaller-cap, more speculative investments, I go with a 35% trailing stop.
When fears over a market selloff materialize, all we have to do is trim up our stops. Doing so keeps us in the market just in case our fears are misplaced, yet preserves our profits at the same time. It’s a win-win.
The most common argument against using trailing stops is that market makers can see our orders – and, in turn, they’ll intentionally manipulate prices to stop us out. I’ll admit that it does happen but not frequently enough to swear off using this type of free insurance.
~Volatility Buster #2: “Put” Your Way to Profits
Buying put options, which gives you the option to sell a stock at a predetermined price, is the closest alternative to using trailing stops. They essentially let you lock in your sale price in advance and there’s nothing a market maker can do to interfere with the strategy…
You have to pay for the option, however, so if the stock never drops below the strike price (i.e. – the stock resumes its rally), you’ll be out-of-pocket the cost of the option but…sometimes it’s worth paying a little for a lot of peace of mind.
~Volatility Buster #3: Get Inverted
Dozens of inverse mutual funds and exchange-traded funds (ETFs) now exist that rise when stocks drop. You can purchase these funds in retirement accounts, too.
ProShares, Rydex and Direxion offer the most popular and liquid funds. By taking a small position in any of these funds, you can help smooth out any market volatility. However, if you plan to hold the funds as a form of long-term insurance, just stay away from the double- and triple-leveraged funds.
~Volatility Buster #4: Bet on the House
We can actually profit from the uncertainty over future interest rates – and stock market volatility – by scooping up shares of CME Group (CME) and CBOE Holdings (CBOE).
- CME exclusively handles trading of interest-rate derivatives so as more and more traders speculate about the next move for interest rates, the company promises to book more profits.
- CBOE is the trading venue for options and futures on the VIX Volatility Index (VIX). Again, as traders get more skittish about the next gyrations in the market, they’re bound to ramp up their bets on the next move for the VIX.
Since the house always wins, it’s best for us to avoid making predictions about interest rates and volatility, and just invest in the companies that promise to benefit from everyone else’s wagers.
~Volatility Buster #5: Buy Value, Not Momentum
During bull markets, many investors get lazy and buy what’s working and they’re all too quick to “pay up” for momentum stocks – but guess what? When volatility spikes, high-flying momentum stocks are the first to give back gains.
Sometimes analysts get lazy and only look at consolidated figures so a company with a division that’s growing at a rapid clip – but happens to own another unit that’s flat-lining – tends to be overlooked (and mispriced) and, since earnings continue to climb under the radar, such companies promise to march higher – even if the multiple expansion for the S&P 500 grinds to a halt. Sure, finding such opportunities requires more work – but it pays…
Since I don’t believe the bull market is over, we should respond to the market volatility by putting new money to work in undervalued stocks with hidden growth potential as mentioned above.
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
*http://www.wallstreetdaily.com/2013/06/25/market-volatility-strategies/ (© 2013 Wall Street Daily, LLC All Rights Reserved; If you enjoy reading our no-nonsense, unbiased research at Wall Street Daily, feel free to share it with your family, friends and colleagues. Simply send them this link, so they can sign up for the TRUTH… for free, of course. Have a question or want us to expose the truth? CONTACT US)
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