The Most Profitable Way to Take Advantage of Rising Volatility
Editor's note: The market is sloshing back and forth... and volatility is on the rise.
That sounds like bad news to most investors and traders. But as you'll learn in this weekend's Masters Series, it should be music to your ears.
Over the next two days, we're featuring an exclusive interview with Matt Weinschenk, senior analyst for Dr. David "Doc" Eifrig's Retirement Trader advisory. As Matt explains in today's installment, higher volatility is likely over the next couple of months... and that's a good thing...
The Most Profitable Way to Take Advantage of Rising Volatility
An interview with Matt Weinschenk, senior analyst, Retirement Trader
Sam Latter: Stocks have marched higher for the past nine or so years. It has been a historic move, but folks on Wall Street have mixed opinions whether the bull market can continue for much longer. Where do you and Doc Eifrig think we are in this bull market?
Matt Weinschenk: It's funny you ask, actually...
On January 24, Doc was asked for his No. 1 prediction for 2018 as part of the Stansberry Portfolio Solutions event. He predicted that the market would experience a double-digit correction in the first half of the year.
Two days later, the S&P 500 Index peaked at 2,872.87 before falling to 2,581.00 on February 8. That's a 10% drop. Of course, he didn't have a crystal ball. But he knew that the market was overdue for a pullback.
Our general viewpoint is that you shouldn't try to trade around typical market corrections of less than 20%. One, it's hard to do. And two, you have to pay taxes on your gains. This means you have to time the correction and the rebound exactly right to make it worthwhile. Nobody can do that consistently.
Plus, it's highly unlikely that we see a 20%-plus correction without a recession happening as well. We've run the numbers on this and it's rare. We looked back to 1939 and found that the market pulled back more than 20% without a recession just five times, or once every 15 years.
When you look at economic growth, employment, and consumer activity, we don't see a recession coming within at least a year, maybe longer.
Sam: What's the ideal market condition for making recommendations in Retirement Trader?
Matt: The best part about our strategy is that we can make double-digit streams of income no matter what the overall market is doing.
In sideways markets, selling options can generate steady streams of income on stocks... even if they go nowhere. So while regular shareholders aren't making any money, our trading strategy allows us to make 16% a year or more on the exact same stocks. That's what we've earned on average over Retirement Trader's 10-year history.
But when markets get choppy, you can use it as an opportunity to buy stocks at a discount. Higher volatility means that options prices rise, which means we can earn higher payouts. In other words, if stocks are falling and investors are getting worried, you can get paid more for your troubles.
Right now, we're in a transitional period. We've had a long stretch of low volatility, but things started to look rocky again when the market pulled back last month. We think we'll see more volatility ahead, but that's what's great about a versatile trading strategy... We don't need to know what's going to happen next.
Sam: Why do you see more volatility coming?
Matt: We know for a fact that volatility tends to "cluster." When markets get volatile, they tend to stay volatile. After all, what makes people scared and think about selling? Other people being scared and selling.
That's part of why we saw such a long, unprecedented period of calm in the market. Quiet markets lead people to expect quiet markets. Investors become complacent. Stocks and valuations rise. But higher valuations and complacency in the market means that when stocks begin to pullback, investors panic.
Based on history, we expect higher levels of volatility over the next couple of months.
Sam: Because Retirement Trader is so versatile, you guys have been able to consistently generate impressive returns for your readers. And in each of the last four annual Report Cards, Doc has earned an "A+" or "A++" rating.
In the most recent Report Card, the returns were staggering: a 93.4% win rate and 44% annualized average returns. What's the secret to your success?
Matt: Investors always want big returns. But they have it all backwards.
Our No. 1 priority is to never lose money. And we've gotten pretty close with that win rate. By hitting singles and doubles rather than swinging for the fences on every trade, we're able to make reasonable gains over and over again. When you make money on more than 93% of your trades, it really adds up over the course of a year or more.
Sam: How has Retirement Trader been able to generate 44% annualized gains in a market that has seen almost no volatility until recently?
Matt: When people talk about low volatility, they're talking about the CBOE Volatility Index (or "VIX"), which measures the overall volatility of the market. You're right, that has been extremely low for a few years now.
But the VIX isn't the only way to gauge volatility. We can still find quality companies that have higher-than-average levels of volatility. When we spot one, we can generate big returns on a company we're happy to own anyway.
Sam: Why do you think more people don't trade options?
Matt: People don't take enough control of their finances in general. And when they have to learn something new and foreign, forget about it.
At first, options trading doesn't make sense to folks. But it doesn't take long for everything to click, and for people to realize it's basic math... And once you get your account set up, it's as easy as trading stocks.
The other problem is that most people use options in the wrong way. They do it to increase their leverage to try and hit home runs in the market. It's easy to blow your account up that way.
Used properly, options can actually reduce the risk in your portfolio. Because we're getting paid to put these trades on, it lowers our cost basis. Instead of buying a stock for $100 and hoping for the best, you can buy a stock for $100 and get paid a few dollars to agree to sell it to someone else at a higher price down the road. We're able to pull income out of the market and put it right into our pocket. That helps keep our win rate high and our losses small.
If everybody tried trading options this way – the right way – from the start, I bet a lot more folks would do it.
Sam: How do you and Doc determine which stocks to trade in Retirement Trader?
Matt: Because Retirement Trader is geared toward folks who are retired and trying to generate additional income in the market without taking on big risks, we don't use leverage or look for risky small caps to make our trades.
Instead, we stick to blue-chip companies. This year alone, we've made trades on high-quality companies like Gilead Sciences (GILD), Intel (INTC), and Starbucks (SBUX).
The key is to only trade options on companies you'd be happy to own... companies you're going to want in your portfolio next month, next year, or farther down the line.
Editor's note: Since its launch, Doc and his research team have logged a 95% win rate on their Retirement Trader recommendations. Earlier this week, he appeared on camera to walk one of our colleagues – a complete investing novice – through this strategy. Watch the presentation and see how she collected $210 in just three minutes right here.