They don’t call the stock market the great humiliator for nothing. While many are pointing to President Obama’s jobs plan and Fed Chairman’s Ben Bernanke’s hints about monetary easing to send stocks higher, it’s tough to find a fundamental reason for the stock market to rally.
Stocks have been in a selloff for a few months now, fulfilling their traditional role of moving in advance of the economy. With each passing piece of data from home sales, employment, and GDP growth, it becomes clearer that we face some tough times ahead, and that a year from now we might even recognize that we’ve slipped back into a recession.
Whether we’re truly in a recession now or manage to skirt by with some negligible level of growth, two assets typically sell off — and sell off hard — during recessionary times.
If you’re long these two assets, it’s best to sell to book some profits.
The first asset to sell is oil. When the world slows down its economic growth, oil is one of the fastest to correct. As a consumer, that’s a boon. It means cheaper prices at the gas pump. But if you own oil stocks, they may get hit hard. Fortunately, that’s an opportunity to pick up shares at better prices later.
The second asset is the Australian dollar. Their economy is tied to commodity exports, namely to China. Typically, Australia is seen as a strong currency play when the economy is growing, as well as a hedge against the US dollar. Unfortunately, the US dollar tends to appreciate during a recession thanks to fear, sending the Australian dollar down.
If your timing is right, some well-placed short sales can increase your wealth in the process.
Let me be perfectly clear: Shorting isn’t for most investors. Typically, to short a stock, you need to borrow shares from someone, and pay them a fee to do so. The more likely the stock is to fall, the more expensive it’ll be to borrow shares. Secondly, your downside is unlimited. If the stock continues to rise, you can lose more than 100% of your investment to cover the short.
That’s why when it comes to shorting I prefer to use put options. The most you can lose is 100% of the premium you pay for the option. You don’t need to borrow shares, nor do you need to pay a maintenance fee for doing so.
In today’s volatile markets, nimble investors should have plenty of chances to short at the end of a strong day in the market, and go long at the end of a weak day for the market.
Although the stock market is in the business of creating fools, you can’t profit if you don’t play. You also can’t profit on an investment like oil or the Australian dollar if you sell once it’s fallen.
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