Three Ways to Play a Reversal for Big Profits If the “Trump Rally” Fails
Monday’s trading was weak right out of the gate and Tuesday’s 0.15% sputter for the Dow didn’t exactly reassure. That’s got a lot of investors wondering if the “Trump rally” is taking a breather, or if we’re witnessing the start of a far more serious correction that would otherwise put a damper on the remarkable 15% run the DJIA has enjoyed since November 8.
It’s too early to call, but there’s no time like the present to prepare for big profits ahead “just in case,” with one or all of the three limited-risk trades I want to share with you today.
Traders Getting “Tactical”
Every Monday morning, long before the sun comes up, I spend a few hours on the phone with a private network of traders around the world – I call them my “friends in low places” – as a means of gauging market tenor, direction, and conviction.
It’s a practice that I’ve followed for years for the simple reason that I gain a much broader view of the global markets than I could on my own. Not to mention, a far more profitable one.
I bring this up because there’s been a definite change in thinking in the last 72 hours.
Traders I spoke with in Hong Kong, Tokyo, New York, and London have suddenly gotten very “tactical,” meaning short-term in their thinking. Having been “long” only since November 8, many are taking trades this week in both directions. That tells me they’re preparing for big profits no matter whether the markets continue higher or lower.
Most investors don’t understand how this is possible.
You mention the word “correction” and immediately “crash” comes to mind. Not surprisingly, I hear from thousands of investors a year who want to “sell it all” under the circumstances whenever I mention stuff like this.
Without getting too far off track, doing so is perhaps the single worst (and most expensive) mistake an investor can make:
- Barron’s research suggests that 85% or more of all buy/sell decisions are made incorrectly – meaning investors are buying when they should be selling and selling when they should be buying.
- Dalbar research shows that individual investors trying to time the markets fall far, far behind. The latest figures, for example, show that the S&P 500’s average annualized return for the last 20 years was 8.19% while the average equity mutual fund investor’s return was only 4.67%. In other words, trying to outthink and out-time the markets cost investors 3.52%, which is like leaving $45,902 on the table for every $25,000 invested over the same time period. I don’t know of too many investors who can afford to do that.
- A staggering 96% of actively managed mutual funds fail to beat the markets over sustained periods of time, primarily because their managers are trying to time the markets.
What most investors are missing is deceptively simple.
Buying and selling is not the black and white decision Wall Street wants you to think it is. In fact, trying to be “all in” or “all out” is a fool’s errand better suited to Las Vegas and back-alley fortune tellers.
The far more profitable course of action is one we talk about all the time and a Total Wealth Maxim: concentrate on what you can control.
Subtle adjustments like the ones I’m going to tell you about today keep you in the game and aligned with the profit potential that can help you build the retirement you want and so richly deserve.
They’re short-term tactical moves that can really boost your longer term, strategic profits.
That’s why I recommend you use them in conjunction with your established portfolio as a means of boosting profits at a time when lesser-prepared investors are left wondering what hit them, yet again.
Here are three of my favorites.
They are all limited-risk, easy to implement, and can be extraordinarily profitable. Plus, you don’t have to sell everything to use one or all of them.
1) Inverse Funds
Inverse funds are a relatively recent invention that allow you to profit from declines that catch other investors by surprise. Typically based on an underlying index like the S&P 500 or tech-laden Nasdaq, inverse funds appreciate when things go to hell in a handbasket.
They’re a great hedge and a limited-risk because investors who buy them are not required to hold “margin” (as would be the case if they were shorting stocks), and because you can buy as much or as little as you want. Plus, the costs are low, which means inverse funds are efficient. Expense ratios of 2% or less are not uncommon and almost every investor can buy them through a normal brokerage account.
More aggressive investors may want to consider double- or triple-leveraged inverse funds – so called because for every $1 decline in the index or sector being tracked, they can appreciate $2 or $3 to profit double or triple the daily return of a specific index. Tread carefully, though. These are leveraged, which means they can work against you in a hurry and are best suited for “hold times” of a few days at best.
2) Index Put Options
Consider buying index put options if you’re a more aggressive investor.
These are like inverse funds in that you are buying something that gives you the potential to profit as prices of the underlying instrument decline. Only here you’re buying a specific “contract” that stipulates how far a stock or index has to fall, by when, and by how much.
I like buying puts because your downside risk is limited to the amount of money you’ve got “on the table” so to speak, and not a penny more. Like inverse funds, there are no margin requirements. However, you do have to have prior approval from your broker to trade them.
3) Buy volatility
Most investors think about diversification in terms of stock or by industry sector, i.e. small-cap, large-cap, stocks, bonds, etc. Very few understand that successful investors (and many traders) also diversify by trading method and, specifically, volatility.
When you think about it for a moment this makes a lot of sense.
We live in a time when every aspect of our financial markets has been turned into a tradeable event. There are stocks, bonds, futures, and options on every one of those things, including the volatility that drives them.
The easiest way to trade that is to buy VIX options that track the implied volatility of near-term S&P 500 options.
The VIX, in case you’re not familiar with it, is the ticker associated with the Chicago Board of Option Exchange’s Volatility Index and represents the expected annualized volatility of changes in the S&P 500 Index over the coming 30 days. Ergo, it’s forward looking.
I like VIX options because they give individual investors the ability to track broad market shifts as they happen, yet avoid prices changes in the underlying investments that drive them including dividends, earnings, interest rates, or even time to expiration, for example.
Many investors find it quite profitable to buy VIX calls instead of the S&P 500 puts I’ve just mentioned as a result.
As I write, the VIX is trading at around 11.44 but hit a 52-week high last June of 26.72. Depending on which options you purchased and when, your profits could have been in the hundreds or even thousands of percentage points.
I’ve obviously just scratched the surface today, but I hope I’ve given you a taste of what’s possible with a little creative thinking.
The way I see it, no investor has to suffer the ravages of a declining market, especially when there are easy, inexpensive, and limited-risk ways to turn falling prices into profits.
As always, I’ll help you find ’em!
Until next time,