How do you build a small fortune in the market? Simple… Start with a bigger fortune. That’s an old joke, but it sometimes appears to be the way the market works. But it doesn’t have to be that way. With enough years in the market and the right investments, you should be able to build a nice tidy little fortune despite the bumps along the way.
The secret is to buy low and sell high. Unfortunately, what a lot of people like to do is wait for the market to run up before they jump in, then buy high and sell low. Right now, the market is starting to look like one of those markets where fortunes could be made.
The news out there is bad. Unemployment is up, inflation is up, housing starts are down, and, despite falling from all-time highs, crude oil is still pretty expensive. What would you expect the news to be like when stocks are low? Bad, of course. If the news is good, stocks are up. So, we might paraphrase the old axiom as “buy when the news is really bad; sell when the news is really good.”
Fear-generating headlines can cause investors to momentarily forget that when prices are low, they should, if anything, be buying. The idea is to accumulate more and more equity shares over a lifetime of investing, riding the long-term prosperity of the U.S. economy.
Having said this, let me make two clarifications. First, continuing to buy low is prudent only in broadly diversified portfolios. A high degree of diversification helps protect you from isolated blow ups. Continuing to buy into the falling share price of an individual stock like that of Bear Stearns recently, or Enron in days past, can be foolhardy. So, yes, buy low, but only in a fully diversified portfolio where your ultimate success depends on the overall economy and not a single company or industry.
Second, buying low doesn't mean prices can't go lower. How low will things go, anyway? You won't know until months after the final bottom. All you can do is determine to be a buyer at prices that appear low relative to their recent highs, or perhaps in relation to recent or projected earnings. The market has crossed into bear territory -- 20% below its October high -- but has come up a bit. It's been a wild and unnerving ride down and it may not be over.
Buying at almost a 20% discount level is a sensible act if you're a long-term investor, meaning at least a ten year time frame before you'll need this money. You might soon have the opportunity to buy more at 25% or 30% discounts... or you may not. The best bargain hunting days may already be behind us. This kind of market environment requires patience and fortitude to stay the course, but long-term investors should embrace the opportunity it offers, not run from it.
Stocks are low and things may be improving. Sure, the word is that a worldwide recession may be starting to heat up, but maybe that recession is already priced into the market and this could be the time to jump in and get ready for the ride up.
You don’t want to get all in too fast. Spend the next three months moving into longer-term bullish positions that are hedged. Move in slow. If prices go up, that’s OK. What you don’t want to do is go all in and we get another big drop. If we get another drop and you have some cash around, you can get even better bargains.
One strategy I have been using lately is to look at, at-(or just out-of)-the-money Jan 2010 leaps in solid stocks like Tiffany & Co. (NYSE: TIF, Stock Forum), United States Steel Corp. (NYSE: X, Stock Forum), Procter & Gamble Co. (NYSE: PG, Stock Forum), and Coca-Cola Co. (NYSE: KO, Stock Forum). To hedge things, sell a Jan 2010 leap at a lower price. My goal is to make a decent return over the next year and a bit. If the stock takes off, I may exit the position if it hits profitability earlier.
Here's a trade on a solid company with an up-and-down price history. Disney (NYSE: DIS, Stock Forum) has been through some tough times recently, but by January 2010 the stock should be doing well. For a hedged trade on DIS, look at the January 2010 30/25 Bear Call spread for a 3.65 debit. That's a 37.0% return and the stock has to fall 6.2% to cause a problem. It is a little closer than I normally go, but the longer timeframe justifies the closer position.
For those of you with the opinion that technology will recover better than entertainment, take a look at companies like KLA-Tencor Corp. (NASDAQ: KLAC, Stock Forum) and Corning Inc. (NYSE: GLW, Stock Forum). For a hedged trade on KLAC, consider the January 2010 35/30 Bear Call spread for a $3.50 debit. That's a 42.9% return, and the stock has to fall 10.4% to cause a problem. There is a little more protection on this one since the stock has been beaten down a bit this year.
With the longer-term spread trade, you get decent returns while still minimizing the risk. You also get to keep more cash on hand and still be in the market. The cash you have can be used to spread your risk even further by diversifying across sectors.
Remember these types of trades are only for a small portion of your overall portfolio. If you are interested in learning more about these types of strategies, we are offering Tuesday and Thursday webinars to help you learn a few more investing tricks. And each webinar includes a live trade. If you are not already a subscriber, go to www.investorsobserver.com/SummerSchoolA3A for more information. If you are a subscriber you will automatically get a webinar invite.
This week Investors Observer covers:
Building a fortune – Could the right moves in today’s markets help you make a fortune?
Articles:
* Some Tips On How To Build A Fortune + Lee’s take on ORCL, GOOG, BLK, AXP, MAR, V, and NFLX
* Looking for Value in the DJIA
* How To Make A Fortune, Even In This Market
* How Can You Protect Yourself In a Rebounding Market?
* Which Move Today Can Build A Fortune For Tomorrow?
Click here to read any of these articles.
Vic Wisemann
Lead Analyst
Vic Wisemann is an equity option strategy analysts with Investors Observer. Mr. Wiseman manages several portfolios for the company and comments weekly on his insights, strategies, and tactics for playing the market to win.
Disclosure: Mr. Wisemann owns and/or controls diversified portfolios of long and short stock and option positions that may include holdings in companies he discusses in his articles.
