How to Profit from a Market Correction: Diversified Trading Strategies

admin — Tue, 19 Jan 2010 08:51:34 +0000

What happened to the stock markets these past two weeks?
Anyone at all involved in investing or trading no doubt personally experienced it- the stock markets went through a major correction! And in these days of the “World Economy” such a correction can be triggered by news from anywhere in the world. As it did this time. Poor economic news from China prompted a sharp world decline in stock prices in just a few days.
And many investors, especially long term investors made big losses.
And they’re probably asking:
“Is there some way I could have avoided making losses during that period?”
Well, the answer is absolutely Yes.
Obviously trying to predict such a correction and get out before it happens is extremely difficult, and honestly more a matter of luck than anything else.
But by diversifying your trading strategies you can definitely avoid losses during such times – and in fact make healthy profits instead!
The key is to employ a mix of trading techniques that take advantage of a variety of trading timeframes.
Avoid putting all your eggs in the “long term” basket and look at complementing your trading with styles that make returns over the shorter term as well:
- Swing trading is an excellent way to capitalize on market movements over a period of just a few days or weeks.
- Day trading of course, allows you to make returns on stock movements within just one day.
And, mix up how and what you trade:
- Include Short Selling in your trading techniques. By selling a stock or index short, you are looking to profit from downward moves. This is just as valid as trying to buy low and sell high. And offers an important hedge against a market correction
- Also, there are now Inverse and even Double-Inverse indices that can be traded quite easily. DOG is the symbol for the Inverse Dow 30 Index and DXD is the Double Inverse Dow 30. By owning these, you are essentially short selling the major stock indices.
And, contrary to popular belief, it is not difficult to begin trading in this manner.
Over the years online trading has exploded in popularity and, as a result, the resources, tools, strategies and infrastructure available to the ordinary investor have become enormous.
- Online brokers offer trading accounts with extremely low commissions that allow investors to trade all kinds of different instruments (stocks, options, futures, forex) over all kinds of different timeframes (day trading, swing trading, long term trading).
- A large number of trading strategies and systems are also available online. And many such systems, offer a spectrum of short term and longer term strategies in a single service.
- And online trading platforms have become very sophisticated, offering complex analysis tools and even the ability to develop and back test trading strategies.
So, what simple steps can you take to profit during rising markets AND market corrections?
- Long Term trading: Allocate a portion of your trading funds to long term investments (over many months). Make your profits from the overall market trends – remember to take those profits periodically so that you’re not caught by a sudden downturn. And look to include some of those Inverse Indices in your portfolio. They can act as a tremendous hedge against market corrections.
- Medium Term trading: Allocate a portion of your trading funds to Swing Trading. In this way you capitalize on the medium term trends in the markets or individual stocks. Practically all financial instruments go through these medium term swings as traders are constantly trying to determine the right longer term price by buying and selling at support and resistance levels. And by taking both Long and Short trades on these swings you stand to profit in both directions!
- Short Term trading: Allocate a portion of your trading funds to Day Trading. This allows you to completely take the longer term market factors out of the equation. By trading within a single day, it really doesn’t matter that there was a long term correction. You profit anyway. With the right strategy, you would undoubtedly recognize the selling opportunity presented on the day(s) when there is a market correction. And by selling short you stand to make enormous gains that day!
- Ask your broker how to set up an account that allows you do trade in this way. You’ll be surprised at how simple it can be to get setup.
Much is written about diversifying your investments. But don’t just look at diversifying your holdings. Diversify your trading strategies too.

Options Trading – Benefits of Leverage

admin — Tue, 08 Dec 2009 22:31:54 +0000

Options are riskier to trade than stocks. That’s fairly well known. And we’ll get into why.
Since options have an expiry date the investor has to make a choice within a relatively short time frame. This adds risk and complexity to the trading scenario.
Also, since options are derivatives, they have no inherent worth. Their value is determined by the value of the underlying security. They can move in sharply different directions from the underlying asset. One can short a stock or go long, but once bought the value of the shares is known. Even after you purchase options, their value is often solely ‘time value’, they’re worth money only because some event may occur in the future, such as a rise in the price of the asset.
But they also offer significant advantages over stocks! And that’s why they’re so exciting to trade.
And one of the characteristics that make them so interesting to many investors is that a trader can make use of the power of leverage.
And the word “Leverage” is no accident. It comes from the word “Lever” . Think back to your Physics classes. You probably learnt how levers can help a small person lift a very large weight. By placing the pivot point at the right spot (close to the heavy object and far away from the person) the small person can lift up a much heavier object! The force the person exerts is “multiplied” by the lever.
Well this “multiplying” effect is exactly what leverage does in trading as well.
The basic idea is that an investor can control a very high valued asset for a much lower investment amount. e.g. An investor could control $2000 worth of a security with an investment of only $200.
Suppose INTC (Intel) is trading at $24 on a given day. A trader who anticipates that the price will rise can purchase one options call contract which confers the right to buy 100 shares.
That call option, with say an expiration date in three months time with a strike price of $26, will cost somewhere around $3. (The ’strike price’ is the pre-set price at which the shares have to be bought if the option is exercised.)
If the shares were purchased outright, even at the lower $24 price, the investment would cost $24 x 100 shares = $2,400 (plus commission). But by buying the call option instead you invest $3 x 100 shares = $300 (plus commission) and control the same number of shares. That ratio, $2400/$300 = 8 is the “leverage”. You have control of an asset that is worth 8 times more than what you’ve invested.
Why is leverage such an advantage?
The answer is that, though the investor takes on the risk of losing the premium (the cost of the contract), that multiplier effect operates on profits in just the same way as it did for the costs. A smaller movement in value of the overall assets controlled becomes a much larger movement in the smaller amount invested.
Suppose INTC rises above the strike price ($26) to $31. If you purchased the shares directly at $24 per share, with $300 to invest, you could only purchase 12 shares. (12.5 if you have a plan that allows fractional share investing, but part of that will go for a commission.)
Your profit on the trade would be (ignoring commissions) 12 x ($31 – $24) = $84. If instead you had purchased an option on 100 shares, your profit would be (($31 – $26) – $3) x 100) = $200.
You had to pay more per share, and the premium reduced your profits, but you controlled many more shares. The net is still considerably higher.
It’s important to remember, though, that leverage also works on losses in the same way. If INTC had fallen in price, but you were obligated to a strike price of $26. So exercising the option would cost you by that same factor. Under those circumstances, traders simply let the option ‘expire worthless’, limiting the loss to the amount of the premium or 100% of your investment…
So treat leverage with respect. But when you have it working for you it can be a huge ally in helping you make tremendous profits trading!

Strangle Options Strategy » Trading Strategies

How to Profit from a Market Correction: Diversified Trading Strategies

Options Trading – Benefits of Leverage