We’ve talked a lot in the past two weeks about when to sell a stock, when to buy a stock and, of course, the importance of fundamentals. By targeting strong earnings and sales growth, you’ll find the right stock that will move higher regardless of which way the broader market turns.
Now, one thing we haven’t talked about is risk tolerance.
Risk tolerance is essentially the volatility you’re willing to take on with each trade. Not everyone can stomach the same level of risk, and not everyone’s investing goals are the same. Maybe you’re saving up for a new car, maybe you’re nearing retirement (or have retired) and want to build your nest egg or maybe you just want to join the investing game. Regardless of why you’re investing, it’s very important to consider your risk tolerance.
I say this because a lot of folks want to make big money fast. So, they turn to very risky trading vehicles like ETFs (exchange-traded funds) or options. Essentially, by buying an ETF, you’re often buying an index. An ETF is a bucket of stocks that can track the major indices, a particular sector or even gold and commodities.
If you’ve invested in an ETF that tracks an index like the S&P 500, you can certainly make good money when the market moves up. However, when the market turns down, the ETF may take a big hit.
Let’s take the ProShares Ultra S&P 500 (SSO) as an example. This ETF tracks twice the daily return of the S&P 500 every day. So, if the S&P 500 goes up 1% one day, then SSO should go up 2%. However, if the S&P 500 is down 2% another day, then the SSO will fall about 4%. Or, if you decide to bet against the S&P 500 and buy a triple inverse ETF, there’s potential for big returns, but only if the market declines. If it moves higher, the ETF will make a big move lower.
And let’s not forget about options, which are just as risky and require a very high risk tolerance. An option is based on underlying securities like stocks. An options contract offers the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying stock during a certain period of time or on a specific date, at an agreed-upon price. That price is called the “strike” price.
One option contract tends to cost about $100, so they are a great way to play expensive stocks. Take Alphabet (GOOGL), for example. The stock is trading at about $1,800 per share. So, in order to own just one share of GOOGL, you have to pay $1,800 (not including trading fees). If you want to own five shares, you’re looking at spending $9,000.
But options are much, much cheaper. You can spend as little as a couple of dollars, and if the stock goes up, the option should go up significantly higher.
However, there is a lot of risk. ETFs and options are extremely volatile, so you need to be prepared for big swings in your investment, and be prepared to lose all of it, very quickly, if they don’t work in your favor.
You should really keep this in mind during earnings season. As we’ve talked about in past blog posts, we’re in an earnings recession now. Many companies – especially large multinationals that are paid in eroding currencies – are set to see a massive deceleration in their earnings due to the strong U.S. dollar and more difficult year-over-year comparisons.
As a result, many analysts have been forecasting negative earnings growth for the S&P in the first quarter, a slight earnings decline in the second quarter and low single-digit growth in the third quarter.
So, going back to the GOOGL example, let’s say you decide to buy call options ahead of the company’s earnings results. If the company does well and reports an earnings surprise, then ideally the stock will move higher.
And depending on the option you buy – and how close its strike price is to the actual stock price – it could make a major move to the upside on just a 1% or 2% move in the stock itself. So you could have a much bigger winner on your hands.
But if the stock falls, then you’re looking at an equally big loss — potentially all of your initial investment in one day. That would have been the case with GOOGL on Tuesday. The company’s earnings of $11.90 per share topped analyst expectations for $10.16, but revenue of $36.34 billion failed to meet the estimated $37.33 billion.
Paid clicks grew only 39% from the 66% growth from a year ago. This means that the company is not growing traffic volumes as quickly to make up for declines in advertising prices. As a result, the stock sold off over 8% the day after earnings (and kept going!) So, had you bought options in hopes of a big move up on positive results, your position could have been wiped out.
The takeaway here is that there’s a lot of risk with options and ETFs. And if you have a low risk tolerance, then you might want to stay away from them.
Now, this doesn’t mean that you can’t make big gains in the short term. You just need to focus on companies with strong fundamentals, sales and earnings growth. This lowers your risk tolerance significantly, since the odds of a “one day wipe out” are lowered dramatically for two reasons:
1) You’re investing in stocks, and thus you own a piece of the company, which has intrinsic value.
2) These stocks have the underlying fundamentals to continue growing.
And because you’re investing in stocks, you don’t need to worry about any special type of brokerage account or clearance for specific levels. All you do is buy and sell the stock. You can even do it over the phone with your broker if you want to!
For these reasons, I use a stock-trading strategy in Accelerated Profits, and it’s rewarded my subscribers nicely. They’ve locked in double- and triple-digit profits in companies like +37% on Shopify, Inc. (SHOP), +68% on 51job Inc. (JOBS), +75% on Arista Networks (ANET) and +100% on Ferrari NV (RACE).
That was all in less than a year — and the gains were just as good as most options traders can hope to make…but with much greater peace of mind.
My system has been delivering these kinds of results for years, so I expect to continue racking up gains like this. And I’m preparing two new recommendations that offer low risk — but high reward — for tomorrow.
I don’t want you to miss out on my next big winners, so go here to learn more and sign up to receive my Flash Alert.