The Omicron Rout: Buying When The Herd Panics
When the coronavirus outbreak first became apparent in the United States last year and tanked the financial markets in February-March 2020, the crisis was the epitome of a “black swan.” Stocks have since recovered and I’m bullish about investor prospects in 2022.
However, as the outbreak of the COVID Omicron variant shows, you never know what nasty surprises could be lurking around the corner. By its very nature, a black swan is unexpected.
In recent days, the rapid global spread of the highly contagious Omicron mutation has rattled investors and generated roller-coaster action in financial markets. Will Omicron fade, in the manner of Delta, and lose its punch as new vaccines are developed? That’s unclear.
But one thing is clear: Selling in a panic-driven market is one of the worst and most costly mistakes you can make as an investor. Focusing on fundamentals is a basic tenet of successful investing. Pullbacks represent a good time to build up existing positions in strong companies or buy into stocks that you didn’t get into earlier.
Volatility can be scary, but savvy investors can use the market’s mood swings to their advantage by knowing how and when to exercise three types of protective measures when buying. Let’s look at the menu.
Limit orders help investors avoid buying or selling a stock at a price lower or higher than they desire. It is an order to buy or sell a security at a specific price, as opposed to a market order, which doesn’t guarantee that your security will be purchased or sold at a specific price.
A buy limit order sets the maximum amount you’re willing to pay; a sell limit order sets the minimum amount you’re willing to lose in an investment. Using limit orders can enable investors to take advantage of stock price dips.
One of the most widely used devices for limiting the level of loss from a dropping stock is to place a stop-loss order with your broker. Using this stop order, the trader will pre-set the value based on the maximum loss the investor is willing to tolerate.
If the last price drops below this fixed value, the stop loss automatically becomes a market order and gets triggered. As soon as the price falls below the stop level, the position is closed at the current market price, which prevents any additional losses.
Stop-loss orders can save you boatloads of money, particularly if the extended selloff occurs at the peak of a financial crisis.
A trailing stop and a regular stop loss appear similar because they equally provide protection of your capital if a stock’s price begins to move against you, but that is where their similarities end.
The “trailing stop” provides an advantage over a conventional stop loss because it’s more flexible. It allows the trader to continue protecting his capital if the price drops, but when the price increases, the trailing feature becomes active, enabling an eventual protection of profit while still reducing the risk to capital.
Over time, the trailing stop will self-adjust, shifting from minimizing losses to protecting profits as the price reaches new highs.
Pros and cons…
These tactics are much riskier in volatile markets. For example, the stop-loss order becomes a market order once the stock hits the designated price threshold. The Flash Crash of 2010 is a prime example of when stop-loss orders should be avoided in volatile markets.
In skittish markets, limit orders are a better option and enable investors to profit from others’ fears. That being said, limit orders involve some risks. It’s possible that the stock in question will never reach the limit price; the farther the order limit is from the current price, the more likely the order will prove worthless and expire. Alternatively, the market price may quickly move past the limit price before the order can be filled.
Trailing stops automatically push sell thresholds higher by a fixed percentage or dollar amount as the stock’s price rises, a seemingly useful service. However, if you’re an investor with a longer time horizon, trailing stops can increase the risk that a bout of volatility can knock you out of your position.
Editor’s Note: I’ve just described time-proven ways to protect your portfolio from potential future selloffs. If you’re looking for an investment method that succeeds regardless of market ups and downs, turn to my colleague Jim Fink.
Jim Fink is the chief investment strategist of Velocity Trader. He’s also a world-renowned options trader. Jim has devised a proprietary options trading strategy that racks up profits regardless of the pandemic, stock market gyrations, or political turmoil.
Jim has put together a new presentation that shows smart investors how to earn massive gains in a short amount of time. Click here for free access.
John Persinos is the editorial director of Investing Daily. To subscribe to John’s video channel, follow this link.