Strategies to Protect Your Capital While Investing in This Market
There are no secrets to dealing with the current stock market malaise. The key is to simply understand, manage, and deal with the inherent risk. I’m not talking just about the domestic risk, but also the economic risk from Europe and China, along with the geopolitical risk in Syria and Ukraine.
As you probably all know, the stock market hates uncertainty and there’s plenty of it. Until the uncertainties dissipate, the stock market will be vulnerable to a correction.
This is not difficult to understand as the stock market, with the exception of the small-cap segment, has not recorded a correction of six percent or more for quite some time. The reality is that the key stock market indices are only down less than three percent from their highs, so we could see additional selling.
Given that the technical picture is bearish, with the key stock market indices trading below their respective 50-day moving averages (MAs), we could be in for more downside moves.
In fact, failure to attract support at the 200-day MA would be negative, based on my technical analysis.
The S&P 500 could trade down to below 1,900 should the stock market correction hold in place. At that point, I would be looking to add to positions if support surfaces.
The fact is that I want to see some chaos develop in the stock market as situations like this usually provide an excellent buying opportunity. Simply put, panic means opportunities.
While the near-term trend is down and the intermediate trend is fragile, as long as the long-term trends remain in place, I would be looking to buy on stock market weakness.
Higher-beta stocks are vulnerable to the most risk, as reflected by the Russell 2000 and NASDAQ. To invest here, you can consider hedging using put options on the indices.
Alternatively, you can also write puts on stocks you like for a strike price at which you are interested in buying. Under this scenario, you can achieve some premium income from writing the put option, while also setting a limit price at which you are willing to buy the stock. Of course, the risk lies in if the stock price falls below the strike price.
Another way you can ride out the bearish bias is to write some near-term covered call options on stocks you hold to generate some premium income. As long as the stock market stalls or declines, you can scoop up this premium income. Should the stock rise, you could be taken out and required to sell your stock at the strike price, which is also fine; just be sure you’re comfortable with the strike price when writing your covered calls.