Sometimes the market seems to have a will of its own, acting deliberately to confound the largest number of people possible. Just when everyone expects the market to plummet, for example, after a monumental event like the Brexit, it stages a rally and breaks out to new all-time highs. As upsetting as it is to lose money when the market falls, it can be almost as disconcerting to watch the market rocket up without you. You imagine everyone around you swimming in profits while you just stand there waiting for a chance to get in. If that’s you, first of all, take a deep breath because you are not alone. Very few people predicted the magnitude and speed of recent gains and according to a recent article in Reuters, investors are holding record amounts of cash in their portfolios. However, it is important to learn from the market and understand how to profit from its moves, even when those moves take you by surprise. Combine a knowledge of options with the ability to analyze equities fundamentally and technically and you won’t have to feel left behind in the future.
The easiest way to avoid missing these unexpected rallies is to have some money invested at all times. Simply dollar cost average into a low-cost exchange traded fund like the SPY. Although at times this strategy will have you buying in when the market is high, you will also buy in at the lows. With a long enough time horizon you can take advantage of the fact that over the long haul, the market tends to rise. However, you do have to expect, and be prepared to endure, some violent drops as we experienced in 2000 and 2009. Part of my personal portfolio is dedicated to this strategy, and it has made good money for me over the years. A knowledge of options can make this strategy less frightening, as options provide many ways to protect your holdings when the market turns. However, that is a topic for another day.
The other way to make sure you don’t miss great opportunities is to combine a knowledge of equities with a knowledge of options. At OptionsAnimal, we put an emphasis on getting to know the securities you trade. We teach fundamental analysis in addition to technical and sentimental analysis and encourage our students to build a watch list of stocks they trade often and know inside and out. The benefit of this is that when the market falls, you already have your eye on great stocks which have suddenly become great values. It’s important to remember that when prices fall, many fundamental metrics improve. For example, when the price you pay decreases, the dividend percentage increases. As long as earnings haven’t changed, a price drop improves the PE ratio, as well as all the other price based ratios such as price to book. If you know your companies well, you can be there to latch on when the fundamentals make the full picture look attractive.
Of course, it’s still frightening to jump in when the market is falling, and everyone seems to be predicting doom and gloom. That’s where options can help. You can use them to limit the risk, even as you take advantage of the upside. The married put provides a simple example. By adding a protective put to your stock buy, you can benefit from the unlimited upside potential, and limit your downside risk. Additional strategies such as collars, calendars and diagonals can similarly help you participate in a rising market with limited risk. In short, the more tools you have in your toolkit, the better able you are to capitalize on opportunities when they arise.