A necessary tool for success in any market environment is to have a plan.
The extreme volatility of the fall 2008 led to a challenging market environment which affected everyone. It is important to remind investors that these can still be some of the best times in the markets to take advantage of unprecedented movements and opportunities. A disciplined trader has the tools and skills to maximize the situations that may leave many unprepared and emotionally vulnerable to news and events.
Please remember to turn the overwhelmed and confused conditions of some investors into a trust of your personal methodology and your risk control plan. There is no such thing as good or bad markets, only ups and downs. The first step in any investment decision is to quantify your risk on each and every position with stops or protective options. Decide what dollar amount or percentage of your account that you are comfortable to put at risk per investment. The challenge is to balance the risk with reward as an individual investor.
All investment decisions should use the same methodology and discipline. Time horizons and strategy will change depending on conditions. The four step process consists of:
1) Identify High Probability Candidates
2) Execute with Proper Risk Control
3) Manage Position
4) Maximize Trend
At the very minimum, protective stop loss placement should be analyzed prior to entry on any investment. The best time to create a plan is before the emotion of the markets movement cloud judgment. Being stopped out can be frustrating but it can be a necessary part of risk control and solid money management.
A covered call strategy can also be an effective method to benefit from the increased market volatility by lowering stock basis cost. A plan must be in place for all positions. Without the discipline of trading with stops as an exit strategy or options for protection, investment success can be increasingly difficult.
As opposed to conventional stops, insurance is available for your portfolio or individual stocks that you may be interested in at certain price levels. While your portfolio may be damaged by dramatic conditions, it is always possible to prevent further deterioration with options. Like any insurance, the greater the protection means higher costs. Option premiums are no different and affected by the amount of time purchased and “deductible” cost.
The steady professional investor analyzes the risks of all decisions and can live with the consequences because of proper account allocation. Often times it does not make sense to risk a large percentage of a portfolio on any one investment choice. Another concern is the time horizon and risk tolerance for different account types. An IRA may have separate investment objectives than an option account designed to speculate.
Consumer pessimism is at all time highs and lows, but is not recommended to trade solely on how you feel about the market. Emotion often clouds good judgment and is detrimental to a disciplined investment plan. Be prepared to invest in any direction and conditions that fit your risk tolerance.
Shorting stocks to profit from downward moves can be as simple as buy low and sell high in the reverse order. Some stocks and sectors still rise in bear markets. Be aware that money may move to other investments like gold, currencies, municipal bonds or treasuries in times of instability as safe havens. Regardless of the investment vehicles, risk must be managed and controlled for the individual investor.
Times of extreme market volatility may increase the opportunities in the marketplace. It may be necessary to lower expectations and rebuild confidence in the investment tools and decision making process that you employ. One major problem for investors is their emotional reactions to what is happening in the financial markets around them and not implementing that disciplined plan for success in any environment.