What Your Options Are in this Investment Climate

by George Leong, B. Comm.

The markets continue to look encouraging, as the DOW is up nearly 20% since its low. The economy is showing some positive signs and there is optimism that the G20 meetings in London will generate more concerted efforts to improve the world’s economic situation.

Yet, despite all of the enthusiasm, you need to be careful and should not chase stocks higher, especially after a stock has spiked. With first-quarter earnings around the corner, I suggest you show some prudence, as I do not expect much improvement for earnings and guidance.

I still get a sense that stocks could move lower towards the recent lows. Some of you who have made some good profits over the last month may want to realize some profits or make sure you have mental or physical stops in place.

But there are other options you can look at as an investor and trader.

First, this is not a “buy and hold” investment climate. Buying stocks and holding them for the long term does not work at this time. There really is no such thing as a “widow” stock anymore. Just ask those who own General Electric Corporation (NYSE/GE) or any of the major banks. Nothing is safe in this environment and you should realize that.

Many of you trade or invest in small-cap stocks, but with the presence of a global recession, small-cap stocks are and will be under pressure. Smaller companies will find it much more difficult to access financing in a slowdown. Equity financing may be impossible to attain during a bear market. Debt financing is possible but difficult to get given the tougher measures to avoid bad debts put in place by the lenders.

The most important thing is prudence. Do not chase stocks higher on a rally, as it will be likely not sustainable in the current market environment. But if you want to trade this market by buying on dips and selling on rebounds, you will need to make sure you have stops in place just in case the support levels fail. This type of trading in a sideways trading market could reap some nice gains. Pick only a few stocks. Become familiar with their trading pattern, and off you go.

Stay on the sidelines and wait for things to settle down. The intraday volatility is intense and is not advised for the majority of risk-adverse investors. Hold cash ready for buying on a dip or when markets show sustainable gains. Do not place funds in high-yielding financial stocks, as these stocks remain vulnerable to downside risk.

Another alternative is the use of put options for a single stock or a basket of stocks where buying put options to match each stock would be both economically infeasible as well as improbable due to the limited selection of put options. If you own a basket of stocks, look for a stock index option that has a high statistical correlation with your particular group of stocks. This strategy will help protect against major losses.

The bottom line is to watch the markets carefully and not to be caught off guard.