Buying A Stock Market Dip: Here Are 4 Strategies To Use
Tuesday, May 26, 2009
by Karim Rahemtulla, Investment Director, Smart Profits Report
Did you miss out on buying Apple (Nasdaq: AAPL) at $80 or $90?
How about The Mosaic Company (NYSE: MOS) for $25?
While investors worry about missing out on stock market rallies, there’s another equally important event: Buying on stock market dips.
While the recent rally has been impressive, markets never move in straight lines for long. And given that we’re still 80% below the highs, we still have plenty of room to run.
So now is the time you want to be getting your cash ready to deploy in preparation for the pullback. But first, you need to have a strategy. After all, it’s tough to buy companies that nobody else wants. And it’s horrifying to watch the market drop, just as you get back in. Nobody wants to catch that proverbial falling knife.
Here’s the solution…
Calling Market Bottoms - Don’t Fall For The Fake
While many simply tell you to wait until the upward momentum has begun again, nobody can call the bottom with precise accuracy. Besides, when the market bottoms, most investors are too scared to invest anyway.
And on the way back up, they’re still too scared because they think the move is false. Then, after 90% of the move is over, just as they’re getting comfortable, they jump back in and get whacked backed down. Better just to stay away from stocks completely, right?
Not at all. For most, having money in cash is a disaster for the longer-term and a prosperous future depends on successful investing. This is what you need to do to prepare…
4 Strategies For Buying On Stock Market Dips
- Set Price Levels At Which You Buy Your Stocks:
For example, this strategy would involve buying stocks in stages, each one lower than the one before.
Let’s say you want to buy Bank of America (NYSE: BAC). Buy the first chunk at levels 30% below the current price (given the volatility of financial shares these days, big drops are more common). Then, the second entry point should be 30% below the first entry point… and so forth. Of course, the percentages I have given are just for sake of this example.
- Use A Strategy That Limits Your Upfront Outlay:
For example, buy LEAP options. You’ll have less money at risk and at least a one-year, possibly two-year, holding period.
- Sell Put Options:
The premium on put options soars when stocks are falling. It also means that as shares fall, you can place a bet on a much lower entry point and get paid for trying to own it. For example, if Visa (NYSE: V) is at $64, the Visa $40 puts are worth $0. At $50, those puts may be worth $1. At $40, they may be worth $3.
- Sell Covered Call Against Your Stock Positions:
These don’t have to be at-the-money calls. Rather sell out-of-the-money calls and lock in some premiums from exuberance. As the market falls, you can buy back your calls for less money, as the premium will decrease. This provides you with a hedge. If the market goes higher - great - you’ll sell your shares at a higher price.
Whether the market falls from here or not is not relevant.
What is relevant, however, is that you’re prepared to invest in any environment, good or bad. That, plus the ability to act under pressure.
And our free Smart Profits Report archives give you plenty of in-depth tips and strategies to do just this.
Karim Rahemtulla
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