|
|
 |
Trading In a Down Trending Market
by Bob Eldridge
www.BobEldridge.com
One of the first impressions that used to come to me when I heard the term 'stock market' was that of someone becoming incredibly wealthy by doing whatever they did there. The second was that of someone 'losing his shirt'! While both situations exist, the truth is probably somewhere between these two extremes; that is, most traders make some money. Maybe they occasionally make a little, maybe sometimes they make a lot, usually after a lot of time has passed. But on average, most probably don't make enough to live on consistently. Like everything else, there's probably a good reason for this.
A view held by most of the non-trading public is that if the market is going up, you're making money and conversely, you lose money when the market slides. Asked about their knowledge of the stock market, most folks would probably have little to share, other than their view of 1929 or 1987 ... or perhaps the first few months of 2001. Those of us who trade for a living often pass this misconception off quickly as being based in ignorance or disinterest. In point of fact, when the market moves violently up and/or down, the majority of investor's fortunes do rise and fall with the market! Now there's not been a law decreed in the heavens somewhere that this relationship MUST happen ... it just does. But WHY is the question. It's easy enough to understand that when the market goes up, decliners are outnumbered by advancing stock prices ... call that a given.
By definition then, MOST stocks traded go up in price when the 'market' goes up ... and the same relationship holds when prices head the other way. That's straight forward enough. But just because these stock prices are up today, there's no guarantee that they'll be up tomorrow. In all likelihood, when a stock moves up significantly enough, it's totally reasonable to anticipate a decline in the price very soon. An equally true extension of that is that if the entire market is up significantly, then look out for a pull back soon as profit takers move in to lock in some of that profit! Hmmm ... that almost sounds ... well, kinda 'predictable', doesn't it? When the market (or individual stock) has gone up significantly, look for a pullback. When the market (or individual stock) has gone down significantly, look for a move to the upside!
It's this relationship which MOST investors totally ignore which can cause MOST folks out there to form generalized inaccuracies about market and stock behavior. I've learned to make a living trading in the market by watching these relationships closely and then capitalizing on them as they happen over and over again!
I've discussed general market up and down movement, individual stock price movement up and down and their cumulative effects on our conceptions about the overall stock market. But these ideas are really too broad to be of much actual 'money-making' benefit to us. For that, let's be really specific. And since it might arguably be the most difficult to accept or believe, let's talk about only one of the ways I've learned to make money in a down trending market.
Most folks know that my favorite strategy is selling 'covered calls'. As you may or may not know, this is a strategy wherein you own stock and sell 'calls' against that stock. For example if you buy Cisco (CSCO) at $18 per share, you might sell the $17.50 call against it at say $1.50 per share. Now you have someone out there with the right to buy YOUR stock from you at $17.50 per share, $.50 LOWER than you paid for it! If they do, you lose $.50 on the stock, but have taken in $1.50 per share for selling the call. That's a $1 net profit ($1000 on 1000 shares) on a DONE deal! Let me show you one way I teach my students how to REALLY capitalize on this concept. I'll use an actual deal I did recently to show you how these returns can really be quite awesome!
In early December of last year, I noticed that Metricom, Inc., a communications company that recently traded for as high as around $45 per share, had declined to below $8. Checking on the fundamentals and technicals (company bottom line and stock chart info), everything looked good and I thought the stock was about ready to rebound. So, I bought 1000 shares at around $7.60 per share. Since I thought the stock might go up soon, I just held the stock. Within two weeks, the stock was trading around $15, and then its rise started to fade out. I immediately sold a $10 call, receiving around $6 per share, or $6,000. Notice what I just did. I had $7.60 in the stock but had received $6 for the call! That means now I only had around $1.60 out of pocket for a stock selling for around $10!
I know, I just said it was selling for around $15, but when I sold the $10 call, I 'agreed' to sell the stock (if anyone ever called me out) for around $10 ... so it's not important what the stock was selling for ... I was only going to get $10! Not a bad deal, huh? Well, as it turned out, the stock was called away from me at $10, giving me an additional profit of $2.40 per share ($2400 on 1000 shares). Now add it up. I made $6 for selling the call, and an additional $2.40 when the stock sold. That's a total profit of around $8.40 on a stock, which only cost me $7.60!! That's a net profit (not counting commissions of around $150) of $8,400 on a $7,600 investment. Go figure that rate of return! And get this; the stock did the same thing again before the New Year a month later. (I'm sorry to report that I didn't jump in on that one)!
Look at a chart of the Dow Jones Industrial Average and the NASDAQ composite during that time. They were both DOWN TRENDING!! My point is that you CAN make money in a down trending market - IF you know what you're doing! All you have to do is know a couple of common strategies and then simply PAY ATTENTION to what's going on around you!
If you have any questions about membership, workshops or just questions about what's going on in the market, please call (877)690-7107 or stop by my web site (above).
|
