Not sure where the market is headed? Here are some guidelines to stick on a post-it note above your trading terminal.
[1] Spot the Big Picture
Most traders spend a disproportionate time looking at individual stock charts, and analyze individual positions. But most individual positions are affected by the major trend of the market. So, step back at least once each week and identify the major market trend. For the past few months the Major Market Trend Indicator has been neutral as the market has oscillated within a range. But this should not lead to a sense of complacency, you must be prepared for a breakout before it occurs so you know just how to manage risk.
[2] The Current Strategy is Probably Not The Future Strategy In anticipation of a trend change, analyze each of your positions. If the bias is to the downside, prepare for a breakout lower. That means you should scan put options that could be applied in conjunction with existing stock positions. And it means short call options should be analyzed for premium and time frames, which could reduce risk and fund the put purchase. A collar trade is a very powerful strategy for mitigating risk in a portfolio while the rest of the trading world is panicking during a precipitous market decline.
[3] Assign a Dollar Value to Portfolio Risk
Anticipate a worst-case outcome for the market and assign a dollar risk amount by which your portfolio will decline if and when that scenario arises. If that amount exceeds your comfort level, consider further protection or hedging tools to lower risk.
[4] Shift Your Mindset From Loss to Profit
Don’t stop at analyzing dollar risk in the event of a decline. Start to think about opportunity. Where can you find profits during the decline? How can you take advantage of a stock market correction so that even if the worst-case decline does take place you will not only be protected but wealthier as a result.
[5] Stick To Your Plan Whatever plan you come up with, provided it’s safe and responsible and within your tolerance for risk, stick to it when the market starts to gyrate. Prepare in the quiet period when the market is closed so that when the action is fiercest in the market you remain calm and disciplined.
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