The Right Time to Take Some Profits

Stock markets are rallying again after the recent bout of selling. But do we continue to ride the upward move or should we take a pause, especially given that the year-end is just around the corner and we need to take some profits and losses?

In my view as a trader, one of my key tenets to success in trading is to have a clear strategy on when to take some profits. Only by having something like this in place can you come out ahead. Let me explain.

With the recent rally, the DOW has surged back above 13,700, while the NASDAQ was trading above 2,700 on Tuesday. In my view, this could be another opportunity to take some profits given that we could see some renewed profit-taking in the upcoming sessions that could see some of your recent gains come back down.

Given the uncertainty of the rally, as a trader or investor, you want to make sure you don’t leave yourself vulnerable to market weakness. If you own stocks or index securities that have returned some decent gains, you might be wondering what to do.

For instance, let’s assume you own a basket of technology stocks that have moved in line with or better than the overall markets. A good strategy would be to take some profits. At the same time, you do not want to miss out of any potential gains that may occur as we move into what may be decent earnings in the third and fourth quarters.

A simple strategy that you may want to consider is to take some profits off the table and then use some of the profits to buy index call options — a bullish play on a stock index.

First, take some profits on your basket of stocks. Second, buy some index calls so that you will continue to partake in any further upside moves in the markets.

The best thing about options is the leverage involved. For a fraction of the value of the index, you can trade the index and take advantage of the gains. In this way, you can take some profits and sleep well at night. At the same time, you would benefit should stock markets continue to rise. You can also play index call options on the NASDAQ, S&P 500, Russell 2000, or DOW. There are also numerous other index options you can buy depending on what you want to trade.

Should the market continue to rally, you would benefit from the index calls. If the market sinks, you would have already realized some profits and would only lose the premium you paid for the index call option. In my view, it is a win-win situation for you.