Bypass the ‘Bear’ Trap

In the midst of every major correction, experienced traders always look for telling signs of possible bottoms — events that signal pivot points for the market. One such development is the sale of the Prudent Bear Fund (BEARX) to Federated Funds (FII).

When Wall Street’s most vocal short-sale mutual fund manager, David Tice, decides it’s time to sell assets tied to the bearish case for stocks, one has to wonder whether he sees the easy downside money already made and the landscape for shorting stocks more difficult down the road after such a sharp pullback in the major averages.

Just as venture capital firms Fortress Capital and Blackstone (BX) went public last year right before the market topped out, let’s hope this sale of the Prudent Bear Fund will prove to be a contrarian indicator that signals a true bottom.

STOP BUYING STOCKS … FOR NOW, ANYWAY

I’ll tell you how you’re not going to make money in this market, and that’s by buying stocks.

I say this as a professional trader with almost 25 years’ experience in the game, and a swing trader at heart. Nothing makes me happier than putting on a quick trade and banking big gains in the space of a couple of weeks. Moving from one position to the next, riding on the success of your last great trade, is exhilarating and, let’s face it, downright addicting.

But in today’s market, it’s impossible to even go on vacation for a couple of days without coming back to find your positions in the red — you’ve got to be on top of your trading account even when the rest of your family is beckoning from the beach.

But if you play your cards right, you can afford to take another vacation to make up for the one you had to spend the whole time behind your laptop!

HERE ARE YOUR CHOICES

There are two things you can do to thrive in today’s market:

1. You can stay in the big names that are paying regular dividends — the companies that might be feeling the pinch from the current market conditions, but the ones that are going to come through it with flying colors.

2. Or, you can trade options and simply simulate the gains you might normally enjoy from owning stocks but without the long-term time commitment.

It seems like everyone on Wall Street and certainly in the financial press wants to say that the bottom is here and that it’s time to start picking up stocks on the cheap. But they’ve been calling for the end to the pain for many, many months now and yet we’re still waiting.

If you’re sitting on the sidelines in cash, you might have saved some dough, but you haven’t really made any, either. That’s no fun. In fact, that shouldn’t even be a consideration when there are so many ways you can be padding your trading account with fat profits … if you only know where to look.

FOLLOW THE MONEY FLOW

Forget the markets, the economic reports and the people on TV who get paid to make predictions that invariably never come to pass.

This summer’s trading action has felt like death by a thousand cuts. The markets are slowly, and painfully, grinding higher — only to be set back by fear, malaise or the wind blowing in the wrong direction, it seems.

If I can teach you anything today, it’s that you should become a student of sector rotation. That is, there’s still plenty of money flowing in the markets, and while it’s leaving the troubled industries like housing and the financials, it’s still there and it’s pouring into high-demand areas like commodities and healthcare.

I do this in my Tactical Trader trading service, and you can do it, too. Simply start by cherry-picking the top-performing sectors, and then take a look at the companies that are doing well — your mission is to find the best of the best names, and to buy call options on them.

So, where do you start? …

BUILD YOUR OWN ETF

Sure, you can buy Exchange-Traded Funds, which represent a group of stocks in a particular sector. You can even buy ETF options. But I encourage you to look very carefully at the specific names within an ETF, and how they are weighted. Some components might be doing well, but if there’s a big loser on the list, it’s going to drag down your trade.

I like to simulate owning an ETF simply by casting a net over the top three to five names. My criteria are simple: I want to see big-volume trading in companies that had a stellar last quarter (i.e., they beat estimates, raised forward guidance and maintained/raised their dividend, if they have one), and are confident that they can up the good work.

Even better for us, it’s earnings season, so the time is now to get a clear picture of how they did during some very tough months and how they’re planning to do, three months from now.

PICK GOOD STORY STOCKS, BUT AVOID THE FAIRYTALES

For the most part, companies try to be forthcoming with where they see their businesses heading in the coming quarters. Remember, Wall Street is also making its own bets on their performance, so even if a company has a spectacular quarter but it falls short of analysts’ estimates by a penny or two, it can sink the stock.

So, sure, a company can make any old projections that it wants to (case in point, many of the banks that still haven’t fully reported how big their losses and subsequent write-downs will be). But for the most part, if a company says it’s going to do well — barring any major disasters, of course — chances are, it will or, at least come very close.

SEPARATING THE WHEAT FROM THE CHAFF

The best part of doing your homework and picking the names with the best potential — other than making money on your own terms, in the time frame you designate because that’s what options trading is all about — is that, if any of them don’t live up to your expectations, you can cut them loose. Plain and simple.

So, if you’re holding on to some winning names and you bank profits in them … and maybe even go back to the well a couple more times because there’s nothing wrong with going back and betting on your winning horses … keep in mind that they might be names you want to own.

Buying call options gives you the right to buy stock at the option’s strike price. And that’s why I like to buy deep in-the-money calls. If you’re riding a stock and it shoots up 10 or 20 points while you’re in your options trade, you can exercise your right to own the stock at any time during the life of your options contract � at the price you agreed to pay (the strike, or exercise price).

However, it’s no secret that stocks oftentimes pause on their way up, or even retrace their steps a bit. If you see the stock running up, up up and then it either stands still or pulls back, that’s a good time to cash out of your option trade. Enjoy the profits and hold on to your original investment dollars to get back on the horse again.

GO ‘BACK’ TO YOUR BEST PICKS, AGAIN AND AGAIN

Stocks don’t just shoot up in a straight line — they do what’s called backing-and-filling, which basically means they build support areas from which they can take off and run to new highs. These temporary dips are great for picking up your favorite names at decent prices before the ride takes off again.

Sure, you might have missed out on some great trades if you were trying to avoid being caught in the “bear” trap that the overall market has turned into. But there are plenty of profits out there for you to capture. So, start looking at earnings reports, trading volume, money flow and performance expectations to pick out some stars of your own to add to your portfolio today!