In today’s Daily Battle Plan (for a free trial click here) I mentioned we would look at a strategy to hedge and protect a long portfolio of stocks. I keep a list of topics I want to cover in the Daily Plan and this topic is timely as the market is short-term overbought today. Coincidentally, I received the following email from a gentleman who graduated our Swing Trading College spring 2009 session, which asks how to handle a declining market should it occur as he describes below.
Hi Larry. Just had a vacation and read about Elliott Wave. Very interesting (and scary predictions of doom!) and I see how the TM rules would protect us from his prediction by avoiding stuff under the 200-day.
…the main thing I was looking for (from the Elliott Wave stuff) was how to invest and protect myself in a deflationary downturn. They go into detail about bank failures and corporate failures and the real answer from them is not even money markets are safe. T-Bills and actual cash are the way to protect yourself. It might make a good topic for the Daily Battle Plan even if you don’t identify Elliott Wave by name. If the market actually does drop below the March lows within the next 6 months it would be great for your clients to understand how the ETFs are derivatives and could be harmed (fail to pay) if their creators (or their banks or brokerage houses) go broke in a crash. www.Elliottwave.com has some very interesting stuff and if it actually started to happen (they predict it will start to happen within the next few months) it would be good to have a safe strategy. I LOVE the Daily Battle Plan and hope to be a customer for a very long time. Please throw in some short stock suggestions once in a while (even if only for a week or so to tease us into buying them every day!). Have a great day.
Spring 2009 Swing Trading College Alum.
Bob brings up a number of important points. The first is that there are a number of firms that are calling for a large market decline. Even though I don’t agree with their outlook, the possibility remains that a double dip could occur. That then leads us to the question of how do you protect your portfolio from the possibilities of a decline?
In my opinion, if you believe prices may possibly drop significantly, a fairly low risk way to protect yourself is with the VXX, the short term ETN on the VIX. The VXX measures the implied volatility of the SPX options. When S&P prices rise, the VXX tends to drop. When S&P prices drop, the VXX tends to rise.
If you look at the VXX levels today, you’ll see they’re at the same levels as they were in early September 2008. Over the next few months the VIX tripled in value more than offsetting the percentage loses in the major indices.
The other interesting thing about going long the VXX at low levels versus its recent past is something that many professional volatility traders like to do, especially late in the summer. They like to buy low volatility heading into the fall. If you look back at the years that they have been able to buy cheap volatility in the summer, you’ll see many years where they had substantial gains in the fall. Last year is one of many years they’ve profited from this strategy.
I’m in no way recommending you go long volatility here. This is a decision only you can make for yourself. But, the better volatility traders buy volatility when it’s low and like to sell it when it’s high. It wouldn’t surprise me, with the VXX so low, if many are again accumulating volatility in anticipation of higher volatility levels this fall.
For Part 2, Click Here.
Have a great weekend!
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