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Back in 1936, the great economist John Maynard Keynes articulated a warning about stock market speculation that still applies today: “When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill-done.”
Recent shenanigans over video game retailer GameStop (NYSE: GME) and movie theater operator AMC (NYSE: AMC) come to mind, as insurrectionist investors use social media chatter to bid those stocks to nosebleed heights, as part of an effort to not only make money but also hurt institutional short sellers.
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We’ve been witnessing a highly volatile week, exacerbated by casino-like speculation over stocks such as GameStop and AMC. The following chart depicts the extraordinary up-and-down activity in GameStop’s stock over the past three months, which plunged 44.29% Thursday after a meteoric rise:
Charles Schwab, Interactive Brokers and stock-trading app Robinhood on Thursday restricted the amateur “flash mob” traders who have been pushing up the prices of so-called meme stocks such as GME and AMC. The moves by the brokerages sparked outrage from lawmakers and regulators who claimed it was a double standard that hampered free markets and favored powerful investors. Robinhood users on Thursday filed a class action lawsuit against the broker’s decision. GameStop was surging again in early trading Friday morning, after Robinhood lifted trading restrictions.
Apple beats (but falls anyway)…
After sharply falling Wednesday, the three main U.S. stock market indices soared Thursday on stimulus and vaccine hopes. The Dow Jones Industrial Average rose 299.83 points (+0.99%), the S&P 500 climbed 36.61 points (+0.98%), and the tech-heavy NASDAQ jumped 66.56 points (0.50%).
Thursday before the opening bell Apple (NSDQ: AAPL) released operating results. The Cupertino giant reported first-quarter fiscal 2021 earnings per share of $1.68, beating the consensus estimate by 19.2% for a year-over-year increase of 34.4%. Sales jumped 21.4% year over year to $111.4 billion, surpassing the consensus estimate by 8.7%.
Sometimes, though, there’s no pleasing analysts. Wall Street expressed concerned that customers in Apple’s latest quarter weren’t replacing their iPhones at the same rate they once did. AAPL shares Thursday fell 3.50%.
In pre-market futures trading Friday, stocks were trading lower. Buckle up, because roller-coaster trading will be the norm for a while. I’m bullish about 2021 overall, but the pandemic and the continuing threat of violent political extremism (such as we witnessed during the January 6 Capitol riots) will keep investors off balance over the near term. Excessive speculation, as reflected by the GameStop frenzy, also is fueling volatility.
U.S. Sen. Elizabeth Warren (D-MA) had this to say on Wednesday:
“For years, the same hedge funds, private equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price.” She concluded that it is “long past time” for the Security and Exchange Commission and other regulators “to wake up and do their jobs.”
Under these uncertain and volatile conditions, there are at least two measures you can take to protect your portfolio. Let’s quickly review them.
You have options…
Part of my overall investment strategy is to buy stocks at cheap prices during fear-induced general market selloffs. Options can facilitate this strategy.
For buying stock cheap during selloffs, I recommend selling puts. For example, let’s say you’d love to buy a stock if it fell in price to $30. Rather than place a limit order to buy 200 shares at $30, you could sell two put options with a strike price of $30 for, hypothetically, $2 per share. If the stock closes below $30 at expiration, the put option would be exercised by the put buyer and you’d be required to buy 200 shares of stock at the $30 strike price.
The benefit of buying your stock through option exercise rather than a limit buy order is that you get paid an additional $2 per share in income, making your net purchase price only $28.
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The great thing about this option-selling strategy is that you can rest easy without worrying about options expiring worthless. You aren’t speculating on stock movement within a limited time period. Regardless of how the underlying stock price moves, selling options reduces the cost and downside risk of your stock ownership.
The only risk, if you can call it that, is you will make less money than straight stock ownership if the stock price skyrockets upward. But missing out on a speculative upside gain is much less painful than losing money…especially under today’s crazy conditions, with the indices posting wild swings and guerilla insurgents on Reddit making mischief.
Another protective tactic is to use stop loss orders. 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 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.
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The upshot: sit tight and don’t get rattled by headlines. During the market’s dizzying twists and turns, remember your goals. Our investment team is here to guide you, every step of the way.
In the meantime, I suggest you take a look at our new report: “5 Red Hot Stocks to Own in 2021.” In this report, we provide the names and ticker symbols of high-quality, rock-solid growth stocks that are poised to soar this year. Click here for your copy.
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John Persinos is the editorial director of Investing Daily. You can reach John at: mailbag@investingdaily.com. To subscribe to his video channel, follow this link.