The right move is so often the most
On a theoretical basis, everyone knows to buy when others
are fearful, to be contrarian, to avoid panic.
On a practical basis, hardly anyone has the discipline and
courage to act.
Here are three ways that the individual investor can profit
from the current volatility. [Please note that I try very
carefully to distinguish time frames. My regular weekly outlook
was bearish last week, and remains so, on a short-term trading
basis. I am still shopping aggressively for long-term
investors, who should often take the opposite side from
Method One -- Go Shopping
The most direct method for profit is to rely on fundamental
analysis to determine value. Market fluctuations are
opportunities. If the market is dominated by fear, so much the
Earlier this year I participated in the
Abnormal Returns "vacation survey,
" a nice concept that allowed Tadas to have a few days off and
still stimulate content that would not otherwise have been
available. (There should be a term for that). My recommendation
for the best book in the last five years?
Joel Greenblatt's The Little Book that (Still) Beats the
Market is a great choice for investors. It is both
educational and practical. It is short and easy to read, but
difficult to follow in practice. Why? Most will not have the
patience to stick with the system for the time required.
The author was featured on CNBC last Tuesday. He noted that
trailing free cash flows were in the best 5% of any time in
history. When this has happened in the past, the market has
rallied by 15% in the next year and "value stocks" have rallied
30%. Check out the
For long-term investors, I
noted last Monday
that there would soon be an attack on the promising news from
Europe. Traders and pundits expect comprehensive and perfect
solutions. This will play out gradually and with
Most of the so-called experts will hate it every step of the
way -- until it is too late to see. So far, it is exactly as I
Wednesday afternoon we bought stocks with the following
- A ten-year history of earnings growth, including 2008,
20% growth rate, 15 P/E
- A company with over 30 years of consistent revenue
- A company with a great balance sheet, solid dividend, and
a P/E under 10
While I like to think we are finding the cream of the crop,
there are so many candidates that any individual investor
willing to do some homework can beat the market right now.
Method Two -- Sell Puts
Put selling has a bad rep! When I started in the business,
leaving the quiet confines of Wisconsin academia in October of
1987, the market was charging higher. Selling puts (an option
where you agree to buy the underlying stock at a set price
during a set period of time) was being offered as a way of
printing money. Since stocks always went higher (shades of the
real estate market) you could sell puts with impunity. The
stock would move higher, and you pocketed the premium! Easy
money. I have a souvenier copy of Barron's from that week. On
the day of the '87 crash, Barron's hit the newsstand with many
ads for these bogus trading systems.
The rules changed, making put-selling more difficult for
everyone, including the individual investor. You really need to
know what you are doing.
With that warning in mind -- this is a strategy that can
work. Here are the rules:
- Pick a stock that you want to own based upon earnings,
price, balance sheet, cash flow, and dividends.
- Pick a price where you would love to buy the stock.
- Sell a put at that price. You will collect the premium.
If the stock trades below your price on expiration, you might
get "assigned" on the stock -- which means you will buy at
the price you set.
- Prepare to be disappointed if the stock does not trade
lower. You will still collect the premium.
This is a great way to play high-volatility
Method Three -- Covered Calls
This is a great method to exploit volatility, but it starts
with fundamental analysis:
- Find an attractive stock -- all of the value metrics
- Look for a support level, either via a chart or your
favorite technical analyst.
- Consider yield via dividends.
- Find an out-of-the money call that you can sell.
At a minimum you collect dividends, stock appreciation, and
the call premium.
You have limited upside in a big rally. If the stock sells
off, you have some protection from the call sale and the
This is the most conservative of the three approaches.
Most individual investors read the headline news and panic.
They do not see when to seize opportunity nor the best methods
for doing so.
My snail mail last Wednesday had (yet another) offer to buy
some gold company that had a field next to one that had already
hit. This is only one example. We all know that these ads could
not be paid for unless the companies involved were making big
I also have my "fear monger" spam filter. It is overstuffed
with unsupported rumors, bad data, and politically charged
messages. Maybe I'll do a post with some headlines.
This is a minefield for the individual investor -- even the
most intelligent people who try to reason and interpret
It has never been more challenging to stay focused on the
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