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Let’s face it: Between the war in Ukraine, rampant inflation, and regular shortages at the grocery store, the unemployment rate and GDP growth rate don’t matter.
Something feels amiss.
I’m not one of those doom-and-gloom prognosticators. You won’t hear me say the sky is falling until I have evidence.
But that doesn’t mean I don’t take the current conditions seriously.
Anyone paying attention knows the Federal Reserve is going to struggle to keep inflation under control without wrecking the economy.
So as investors, what can we do? How do we balance uncertainty with the possibility that everything will likely turn out just fine?
After analyzing markets over the last several decades, I’ve crafted three strategies any investor or trader can implement when the outlook gets cloudy.
1. Shorten Your Investment HorizonDealing with uncertainty requires investors to become nimble.
I’m not necessarily talking about checking the chart of every stock in your portfolio five times a day.
Rather, you want to be able to make adjustments if and when something important happens.
For example, Federal Reserve meetings happen pretty often; they host eight regularly scheduled meetings every year, with additional meetings as needed.
In the latest meeting, last week, the Fed raised interest rates by 0.25%. Before the meeting, no one was really sure whether it would be 0.25% or 0.50%. After the meeting, the Fed told investors to expect another six 0.25% rate hikes before the end of the year.
But what happens if the economic outlook changes? What if inflation ramps up or suddenly slows?
The Fed isn’t locked into its outlook. It can change its strategy.
You should as well.
Instead of looking for investments to hold for one to three years, consider looking at some that last six to 12 months.
That change might be difficult if you are used to buying and holding companies for the long haul.
But you don’t necessarily have to change the stocks that are currently in your portfolio.
Rather, you want to reset your expectations for those you plan to add.
You see, with increased uncertainty comes increased volatility. In the last few weeks, we’ve seen markets swing hundreds of points in both directions.
We can use that to our advantage by becoming more conservative in our entry prices.
Let’s use Apple (AAPL) as an example.
Here is the daily chart for Apple, where each day is represented by a candlestick.
Going back to October, you can see that the range for Apple is between roughly $138 and $180, which it reached in December.
Right now, we’re somewhere in the middle.
Now, if I believe Apple is a good company and will outperform the market over time, one way to ensure that I give myself the best chance at harnessing that outperformance is to wait for Apple to drop near the bottom of its range.
Maybe Apple will get there, maybe it won’t. That’s OK either way.
If I create a watchlist of 10 to 20 stocks with ideal trading ranges, chances are good that a few will get down to a nice discount price.
However, I only want to buy the stock if the reasons I wanted to buy it haven’t changed.
For example, one of Apple’s major suppliers, Foxconn, was closed when Shenzhen implemented a Covid lockdown. Though it reopened a few days ago, it isn’t operating at full capacity yet.
Short-term, that shouldn’t hurt Apple. However, let’s say the supply disruption takes more than a month to fully resolve. That’s a problem. If Apple’s share price drops due to that shutdown, I may want to pass on buying shares of Apple.
Apple may be a great stock long-term. But I’ve changed my outlook to a shorter time frame. And right now, Apple has additional risks it didn’t have before.
Again, shortening your investment horizon doesn’t necessarily mean you pick different stocks. It means you wait for more conservative entries on stocks you like that have their stories intact.
2. Lock in Your AdvantageOne of the really neat things about volatility is it creates an opportunity to use options.
As you may recall, higher implied volatility leads to higher option prices.
One strategy I talked about recently is covered calls. This is a great options trade that allows you to generate income from shares of stock you own.
And when volatility is high, you get paid more for these trades than you would during calmer markets.
So why not lock in that advantage?
With covered calls, you pick the expiration cycle for the option you sell. It can be as soon as next week or all the way into next year.
Normally, I like to keep things tight and only go out a few weeks.
However, with implied volatility higher than normal, why not lock in these good prices for a little while longer?
I can go out 90 days or even six months with a covered call, generating income and locking in the higher implied volatility rates.
And if stocks drop from current levels, then that covered call income provides a nice cushion from the fall.
3. Look at Uncorrelated AssetsMaybe you haven’t noticed, but small caps have been doing rather well this year after lagging tech stocks.
Small-cap companies often march to the beat of their own drum and trade somewhat independently of the broader market.
While that can require more research, it’s also a great way to pick up companies that aren’t necessarily going to collapse should the rest of the market take a nosedive.
Here’s a great example I just pulled from TradeSmith Finance using our Screener tool.
This oil and gas company is a tiny outfit that did just over $159 million in revenue last year.
Across the bottom of the chart, you’ll see the TradeSmith Finance Health Indicator, which just turned green on March 11.
Plus, our system triggered an Entry Signal that same day.
This is a perfect trade for this environment. It’s got the oil-and-gas story and technical momentum, and it’s a small cap.
Final ThoughtsAlthough these are three excellent strategies, they aren’t the only ones available when the market outlook becomes questionable.
What are some ways you handle market uncertainty? How do you balance the risk of a downturn versus the risk of missing out on the next leg higher?
Email me and let me know. While I can’t respond to everyone, I promise to read each email.