How to Manage Risk with Stop Losses and Options

Chris Versace

Chris Versace is a financial columnist and equity analyst with more than 20 years of experience in the investment industry.

You’ve probably noticed the sharp snapback in the stock market during the last few weeks.

My question to you is: what have you been doing about it?

You may be thinking that you’re fine because you’re investing in the market.

If so, nice going. But if you aren’t invested, you really should get going. You don’t want to be one of those millions of Americans who lacks a retirement plan or has to live paycheck to paycheck during your golden years.

Back to my question — what have you been doing as the stock market climbs higher and higher? Did you know that so far this year that the S&P 500 has put in 49 new highs?

As I’ve shared with subscribers to my investment newsletter, PowerTrend Profits, managing risk and knowing when to take profits are as important as picking winning stocks. Fortunately, picking winning investments is something my subscribers are more than familiar with, given that they are profitable in 16 of 20 positions in the PowerTrend Profits portfolio.

So how do you protect your investments, particularly those in individual stocks?

There is the easy trap of simply letting them run during a strong upward move in the market, but these are volatile times. With the prospects for growth in China, and the euro zone and Japan slowing, I don’t see that volatility vanishing anytime soon.

At the same time, you don’t want to sell too soon and miss out as a stock marches higher.

The approach I take in PowerTrend Profits is to use stop-losses to limit risk in a stock position. Over time, I ratchet that stop loss up as the shares move higher.

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The better-than-11% snapback in the S&P 500 since the October lows has given my subscribers and me ample opportunity to lock in gains of more than 20% by setting or re-setting stop-loss levels. Just last week we did this to five stock positions that include a cashless consumption play, two food-related plays, a company benefitting from the water shortages and drought conditions and a leading broadband and security company.

Whether you’re concerned by the domestic stock market at or near overbought conditions, stimulus efforts in China, the euro zone or Japan that could yank investor dollars from the United States or simply looking to strategically harvest and re-deploy profits, stop losses are a great way to minimize risk and losses.

Another strategy is to buy an inverse exchange-traded fund (ETF) that is constructed to profit from a decline in the value of an underlying benchmark. For example, the ProShares Short S&P500 ETF (SH) or the ProShares Short Dow30 ETF (DOG) are designed to deliver profits when the S&P 500 and Dow Jones Industrial Average fall.

When the market is getting a little frothy, I sprinkle inverse ETFs in my PowerTrend Profits portfolio, but the real returns come when the market is falling and subscribers to my PowerOptions Trader service heed my call to trade call options on inverse ETFs. Those inverse call options can deliver big profits in the short period of time the stock market falls. For example, when the stock market dropped between mid-September and mid-October, PowerOptions Trader subscribers that listened to my advice could have pocketed a 168% return by trading the SH October $23 calls.

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PowerTrends Option Education Series

I know trading options may sound a little scary if you’ve never done it. But in the last 12 months, more than 70,000 TD Ameritrade clients did something they’ve never done before… they placed their very first options trade.

It is a clear sign of a growing shift in investors’ attitudes towards options trading.

That’s why, from time to time here in PowerTrend Bulletin, I’ll share with you:

What options are, and how they work…

Real options trades from my PowerOptions Trader portfolio, and…

Options strategies, definitions and resources you can use as a foundation for trading options.

What am I asking from you?

Nothing at all. If you’re interested in learning more, simply send me an email at CustomerService@ChrisVersace.com with your options question, and I’ll do my best to answer it in follow-up editions of PowerTrend Bulletin.

In the meantime, feel free to read my special report, “The Little Black Book of Options Secrets.” Click here for free access.

In case you missed it, I encourage you to read my e-letter column from last week about the beginning of the holiday shopping season and my online shopping trifecta. I also invite you to comment in the space provided below my commentary.

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