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The U.S. jobs report is out for May, and you know that the news isn't too great…
The unemployment number dropped to 4.7%, but only 38,000 jobs were added – the lowest number in nearly six years.
As you might suspect, we're likely going to see a bit of uncertainty in the markets – especially as we wait to find out whether or not the Fed will still raise interest rates.
The good news is, as traders, we can prepare ourselves for any market reaction – good and bad.
And the way to do it is shockingly easy. It just takes a solid risk management plan…
Diversify Your Portfolio to Collect Profits in Good and Bad Markets
There's a common misconception in the trading world that falling markets mean falling profits. And for this reason, many traders often shy away from bearish trades. Remember, when you're bullish, you're anticipating an upward market move. When you're bearish, you're anticipating a downward market move.
But just like the investments in your retirement plan accounts, diversification is the key to minimizing your risk in any market… and especially when there's uncertainty in the markets following a big announcement, like today's abysmal jobs report.
That's why having a mix of both bullish and bearish trades in your portfolio whenever you possibly can is the best way to prepare for bad market reactions – and good ones, too. When you're 100% invested in bulls or bears only, the ramifications can be severe.
Just think about SunEdison Inc. (OTCMKTS: SUNEQ)… there were a lot of people throwing all of their money into it when it was trading at $5.00. It's now trading at $0.15.
You can do the math on that one – and it's not pretty.
Now don't get me wrong… when the going is good, it can be REALLY good. And when the market moves the way you anticipated, you've got a nice collection of winning trades and the kind of cash people write songs about.
But if all your trades are bullish and require the markets to keep moving higher… It only takes a single event to sink your entire portfolio – a bad jobs report, an investigation like the one we saw this week with Alibaba Group Holding Ltd. (NYSE: BABA), or heaven forbid, some global catastrophe.
The markets have a tendency to fall in price faster than they rise, and usually by a much larger percentage. That means, as I'm sure you know, that you can lose a lot of money when markets are going down, and you can lose it fast!
That's why I've spent the past decade not only helping traders and investors learn the ins and outs of options trading – but also the importance of diversification and having a mix of both bullish and bearish positions in their accounts at any given time. And I'm not just preaching this… I'm doing the same thing in my own portfolio.
Remember, for us traders, volatility in the markets doesn't mean that we have to lose money – it actually means we've got an opportunity to make money in BOTH directions.
So don't put all your eggs into one bullish basket… welcome the bears too. It's a great way to cut your risk and balance your holdings.
And speaking of bears…
Find the Best Bearish Trades by Following the Bid and Ask
There's a possibility that you may still be on the fence about putting bearish trades in your portfolio (pun intended).
And if you are, I've got some great news for you…
You can land the best bearish trades for your portfolio by simply following the bid and ask prices.
In fact, I use exactly the same screening technique to identify both bullish and bearish trade ideas for my publication, Money Calendar Alert. So you may already be familiar with what to do.
First, I run a few screens to get a list of the week's top moving stocks (we'll talk more about how to identify "top movers" in the future). Then I check those stocks against my proprietary trading tools, Money Calendar and Darknet, to look for undervalued companies that have pulled back and are ready to make a dramatic upward moves. If one of these top-moving stocks makes one of these lists, that means we've got a green light on initiating the trade. And if a stock makes both lists, then we're in a really good position to double our money the trade.
Keep in mind that we're not necessarily looking for the stock that will drop the most in price when we're on the hunt for the best bearish trades. For example, if a stock shows the possibility of an eight-point move to the downside, but the options are thinly traded, a better trade idea would be on an option that has better liquidity.
Now this is very important…
Liquidity is basically your ability to get in and out of a trade easily. The difference between the bid price and the ask price is called the spread. The closer the bid and the ask prices are, the tighter the spread is. And that speaks to an option's liquidity.
We'll be looking at liquidity much more closely in the near future. But what you need to know right now is that liquidity is a good indicator of how much a stock has to move for you to make a profit on your options. With spreads below $0.05, which is where I like to target them, the slightest move in a given stock can push your options into a nice, money-making range.
So when you want to make a bearish options play (or bullish, for that matter), look for a tight bid/ask spread. Volume and open interest in an option are also indicators of liquidity – but the best indicator is the bid and ask spread. Remember, the tighter the spread, the better.
Sometimes, No Trade Is Better Than a Bad Trade
You know that mixing bullish and bearish trades is the best way to minimize your risk and prepare for ANY market news.
But there could be times when there just isn't a good bull or bear.
And when that happens, what I've learned in my nearly 30-year options trading career is simply this…
Sometimes, the best trade is no trade at all.
So you don't want to force a trade when there isn't a good one – just for the sake of having a trade. And if you find a good bull but not a good bear (or vice versa), then that's okay too.
One last note…
If you find yourself in a position where you have only bullish or only bearish trades in your portfolio, don't sweat it too much. Just make sure you don't put ALL of your money in those positions.
Never forget that cash is a position, and keeping some of your capital liquid is essential. That way, when something rattles the markets (like a horrible jobs or earnings report), you don't have 100% of your money tied up in trades that simply aren't working.
How to Profit Like a Pro Trader, in Two Places at Once: In trading, timing is critical – and with these three simple orders, you can get perfect entries and exits every time without being glued to your screens. Better yet, they can actually slash your downside and boost your profits, too…
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.