Let’s Talk About Risk…
Managing risk is a crucial step in any investment plan.
However, risk management can get even harder during periods of increased volatility. Even though I always say that volatility equals opportunity!
When it comes down to it, buying or selling under extreme market conditions without using stop loss orders can be more of a dangerous gamble and less of an investment.
And choosing where to place that stop can be difficult…
The goal is to give your stop enough flexibility to allow for market fluctuations, yet tight enough to prevent unnecessary losses.
For traders, getting stopped out can be extremely frustrating. But not getting stopped out on a position that moves against them is often even worse.
Luckily, I have an easy solution to this problem that I’d like to share with you.
An often-overlooked trick that can completely eliminate the need for stops while limiting and quantifying the risk is to use a call or put for protection instead.
Buying a call or put option allows total risk control in even the most volatile markets. The option right to sell with a call protects a long position or a put protects a short position.
The option puts in a price floor below or a ceiling above that can be exercised anytime. The risk is the dollar difference between the entry price and that option strike. Simply buying a put or call instead of an exit stop at an entry price provides risk control with staying power to ride through ups and downs.
It’s important to remember that an option is protection for a specific time period. This insurance has a cost in the premium paid. This cost is offset by the peace of mind in a market meltdown, knowing that you can’t be forced out of the position by a short-term move.
Bottom Line: Use a put or call as protection and as a way to avoid being stopped out, while employing the risk control needed for money management discipline.
Keep it In the Money,
Trading Tip of the Day: Don’t Be a Hero…
In periods of increased volatility, you might see previously strong trends buckle under selling pressure.
When the herd is rotating out of a strong trend, high flying stocks might experience some hard sell-off. It’s important to recognize when a rotation is happening so you can avoid getting left behind.
The last thing you want to do is get stuck with sold-off stocks after the party has ended…
The market can be pretty irrational, and with sensationalist headlines frequently swinging things up and down, you want to make sure your money is in a part of the market that’s working.
Now this is certainly easier said than done, but if you take some time out of your days to look into what’s really going on in the market (outside of the news stories) you’ll start to get a good idea of which trends are strongest.
Remember, there’s nothing wrong with being a follower when it comes to stocks…
Be sure to stay on your toes and stay informed so you can protect your portfolio from crumbling trends!
— Greg Guenthner