Market rallies last as long as they last and then the market corrects or crashes. The business of trading a market correction comes to mind as the S&P 500 passes the 2000 mark. The S&P 500 is an index of stocks and is a broad measure of the US economy. As the country has climbed out of the worst recession in three quarters of a century so did the S&P 500 climb out of the abyss. In early March of 2009 the S&P 500 fell to its low after the market crash. It touched 683, down from 1503 in June of 2007. Anyone who bought into an ETF that tracked the S&P 500 made money as it rode up to 1340 by June of 2009. The index corrected at that point by about twelve percent and then has risen steadily to its current level. Both June 2007 and June 2009 were good times to make money by trading a market correction. Now, as the broad advance of the S&P 500 goes on five and a half years is a correction in the offing. If so how can a stock trader make money trading a market correction? Think about technical analysis and think about trading stock options.
The Value of a Stock
Stocks are trading at historically high price to earnings ratios. Bears will say that this is a sign of a coming market correction. But, as rallies play themselves out there is always a point at which some stocks appear to be overpriced but continue to go up in price. The point is that stock value, like beauty, is in the eye of the beholder. The stock investor who does not see any better places to put his money will likely continue to pour money into an overpriced stock market because in his mind’s eye the market is not overpriced. Europe is still flirting with recession and offshore investing in places like China is suspect with Chinese manufacturing slowing down and the distinct possibility of a Chinese real estate bubble bursting and taking the Chinese economy with it. So many third world economies are dependent on selling raw materials to Chinese industry that a Chinese collapse would take many other nations with it. Thus the USA with its slow and steady recovery may appear to be the best of the lot for many investors. But there comes a point when enough is enough and you find yourself trading a market correction or its aftermath. How can you hedge risk in this event?
Perhaps you have purchased a volatile stock and have been pleased to see that it just keeps going up. Your analysis of the stock and the market tells you that the stock has a little way to go before you need to get out. But, there is always the chance that you will get caught in a correction when the market gaps down one morning and opens on the bottom side of your trading stops. Think of trading strategies for an uncertain market. There are two things that you can do to prevent this problem. One is to habitually take a little profit as you go. The other is buying puts on the stock. Buy puts on your rising stock and you have locked in a price at which you can sell, even if the market tanks and takes your stock with it. The price of this insurance is the premium you pay for the option. If the stock continues to climb you can exit the contract and purchase again at a higher price. Trading a market correction in this way guarantees that you do not lose everything that you gained on the way up.
Popularity: 1% [?]