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Editor’s Note: During periods of market turbulence, fear can lead far too many investors to make costly slip-ups. But one trick for conquering that fear is recognizing that with great volatility comes great opportunity — as long as you take the right approach. If you are interested in learning about a strategy that thrives in times of volatility, I encourage you to watch TradeSmith Senior Analyst Mike Burnick’s presentation on the subject here.
Markets don’t make investing easy.
Sure, things were simple decades ago when you could rely on the buy-and-hold approach.
But those days are long gone.
Day after day of 700-point flops and pops in the Dow try our patience. Sensational headlines and talking heads only add to the fear and alarm.
I can’t tell you how many people let their guard down and succumb to panic.
We saw it happen during the Great Recession and the following decade, when far too many folks were underinvested in the market.
You can’t sit back and let your stocks take a beating. But that doesn’t mean you need to liquidate and purge your portfolio, either.
Every one of us can combat the fear of market failure — that anxiety that nags at us day and night hinting, at the worst possible outcomes.
I’ve got three easy steps you can take to keep your emotions in check and not only survive but thrive in market volatility.
Each step builds on the last. So make sure you read through all of them to get the entire picture.
1. Recognize Fear and Why It HappensAt a young age, we all learn about our fight-or-flight instincts. It’s embedded in us just as it is in most living creatures.
Despite our higher-functioning thinking, we can’t escape these instincts.
In trading and investing, they predispose us to avoid pain more than seek gratification.
Consequently, we tend to sell as fear climbs and buy when excitement hits its peak.
That’s the exact opposite of what we should be doing.
The thing is, we all feel fear and excitement. You can’t will them away any more than you can avoid smiling at a funny joke.
Instead of trying to fight them, go for a more proactive approach.
Accept that you will feel these emotions. Rather than fight them, acknowledge that they will happen and plan for them.
2. Create an Airtight Investment PlanThat brings me to the second step: creating an airtight investment plan.
This isn’t how you can turn your $100,000 account into $1 million over a decade, or what you should save for retirement.
I’m talking about developing a decision-making framework for when markets fall apart.
We already know that when stocks go into a tailspin, emotions run hot. Your blood starts pumping while the anxiety begins to steadily rise.
This isn’t when you want to start thinking about what to do.
This is when you need to know what to do.
An airtight investment plan prepares various scenarios and decisions ahead of time so you don’t have to think when the moment arrives; you just act.
In a previous article, I laid out an example of what this might look like.
Here’s the key to making it work: Engage with your portfolio enough to adjust to changing market conditions but not so much that you risk overtrading.
For most of us, we want to have three to five actions to take every week in our portfolios.
This serves two purposes. First, it helps calm the nerves and puts us back in control of our futures, rather than riding the market like a rodeo bull. Second, it keeps us connected to the market.
People who throw in the towel miss the rebounds that occur after a decline.
On the other hand, someone who tries to manage every stock they own tick by tick overthinks and then overtrades.
Both approaches leave you worn out and poorer for the experience.
Three to five actions per week create a nice balance where you can adapt to market changes without staring at charts all day long.
So, how do we decide what those three to five actions should be?
3. Take Measured RisksWhen markets swoon, opportunities arise.
However, you want to avoid flopping around from one trending stock to the next in the hopes of scoring your next 10-bagger.
You can use simple strategies that take advantage of the increased market volatility.
In fact, it’s a great time to become an options seller.
I talked about this in a recent newsletter where I discussed using cash-secured puts to pick up those forever stocks you want to own.
Selling cash-secured puts during market routs on quality names like Apple (AAPL) and PepsiCo (PEP) pays you higher option premiums (the price of an option) than you would receive during calmer markets.
Here’s how you might bring this all together.
Let’s say I already own Apple and PepsiCo stock and would like to add to those positions if the stock drops far enough.
We know that implied volatility is elevated, driving up option premiums.
Taking a page out of TradeSmith Senior Analyst Mike Burnick’s book, I can create a plan that takes advantage of both market volatility and options.
I’ll use Pepsi as our example.
- I’ll create a trading range based on the last three years for the stock and divide it by two. Pepsi hit a low of $95.94 on May 9, 2018, and a high of $177.24 on Jan. 21, 2022. The midpoint is $136.59.
- When the stock is in the upper end of the top half of the range, I sell a covered call option against the shares I currently own to collect a premium that is elevated due to high implied volatility.
- As the stock drops below the halfway point, I can close out my covered call and take my profit early if I choose.
- When the stock nears the lower end of the bottom half of the range, I sell a cash-secured put and again collect a premium that is elevated due to high implied volatility.
This strategy works great because with a decent-sized portfolio, I’m looking at three to five actions per week, whether they be opening or closing covered call positions or opening or closing cash-secured put positions.
I want to highlight that although this isn’t an aggressive strategy, it uses implied volatility and price swings in stocks to generate income.
And if we get a market that bounces sideways, it’s a blueprint for some serious cash flow.
So, what other strategies do you like to use when markets are exceptionally volatile? How do you keep your emotions in check and manage risk without panicking?
Email me and let me know. While I can’t respond to each letter, I promise to read every one.