3 trading strategies for a choppy market

I feel your frustration. After the market bottomed in March 2020, you could throw a dart at any stock, buy it, and make money. Then we moved to a phase where you just had to hold Big Tech names. We are now in a stock market desert – a place where people wander, thirsty to find an oasis of profits. It is not easy. But it doesn’t have to be that hard either. In fact, I know three strategies you can use to generate income in a sideways market.

1. Put options

Sideways markets play with our emotions. As they move up and down you get the feeling that they are about to break the range, only to watch them reverse. Inevitably, when you try to be cute and sell high or buy low, that’s when it ends up breaking out. We may use options strategies to take advantage of range related moves and generate additional income.

For stocks we already own, I like to use covered calls.

As a reminder, a covered call is selling a call option, usually out of the money, for 100 shares you own. This pays you a premium, the price of the option contract, which you keep no matter what. If the stock expires and stays below the strike price you selected, the option expires worthless and you walk away with that premium. Using the Options Screen in TradeSmith Finance, I can toggle various filters on and off to come up with different trade ideas on the stocks I own. Here is an example using Google (GOOG).

Source: TradeSmith Finance

In the boxes above, I have filtered the call options that I can sell on Google. The above parameters are displayed for bare calls. However, they also give me the information I would need for a covered call. As of this writing, Google is trading at $2,831. Assuming I owned 100 Google shares, if I sold the first option, the $3,130 call that expires May 20, I would receive a credit of $2,880, or $28.80 per option contract. The Probability of Profit (POP) shows that there is a 55% chance that Google will end below $3,130 at expiry, based on current implied volatility.

If Google was limited, I could sell this option expecting Google to stay below the $3,130 strike at expiration and keep that $2,880 credit. If Google closes above $3,130, I can still keep that $2,880 credit. However, I lose any upside gains past $3,130 because I would have to sell my 100 shares. Ideally, I want to use this idea on stocks in my portfolio that aren’t as healthy in the short to medium term but that I believe in for the long term.

2. Find stocks with relative strength

Have you ever noticed that there always seems to be one industry that outperforms the market no matter what? This is called relative strength. Sometimes it’s cannabis stocks. Sometimes it’s solar power. Sometimes it’s an industry you’ve never heard of. However, TradeSmith Finance Momentum tools can help you pick stocks and sectors that are doing better than the rest of the market. Energy and technology stocks are the perfect example.

relative strength

Source: TradeSmith Finance

With crude oil prices soaring, energy stocks have had a tremendous resurgence. But that comes at the expense of tech names that can’t seem to get a break. In fact, some of the pandemic’s biggest – Zoom Video Communications (ZM), Fastly (FSLY) and others – are down more than 50% from their highs. Yet names like APA Corp. (APA), Occidental Petroleum Corp. (OXY) and Devon Energy Corp. (DVN) are at or near all-time highs and don’t seem to let off the gas (pun intended) anytime soon. soon.

3. Swap the lineup

Earlier I alluded to a situation where you might try to “get cute” and sell the high of a range so you can buy it back lower. This strategy can be used, but not randomly or indiscriminately. It must be targeted and specific. Here’s what I mean by that. AT CommerceSmithwe talk a lot about momentum and how trends in stocks can move it in a particular direction over time.

However, some stocks trade sideways for years at a time. Sudden upward or downward movements in these types of stocks can create an opportunity. When we see a sharp move that sends a stock’s price up or down a range, that’s when we can look to take a trade in the opposite direction. If you own the stock, you can sell part of your position at the high end of a range and/or buy it back at the low end. This is called trading around a central position.

Conversely, you can sell options as we saw earlier. The Bollinger Bands indicator is a way to tell if a stock is over- or under-extended in one direction or another. Bollinger bands look at a closing period of the stock, usually 20 to 21 periods (the length of each measured “period” can vary), and calculate a specified number of standard deviations, usually two, above and below the current price. Mathematically, the indicator says that based on the entries, the stock’s closing price should be between the upper bound and the lower bound 95% of the time for two standard deviations (99.7% of the time for three standard deviations).

Here’s an example using IBM (IBM), which has been known to go nowhere for the past two decades.

IBM weekly chart

Source: Trading View

The chart above measures the weekly movement of IBM stock within each candlestick. In recent years, the stock price rarely exceeds $145 on the upside, denoted by the upper orange trendline, or $105 on the downside, denoted by the lower orange trendline. The area shaded in light blue is the range defined by the Bollinger Bands indicator using two standard deviations over 20 periods. What I want you to notice is that as IBM approaches the upper or lower trend line and the upper or lower Bollinger Bands, it often comes back the other way. This is where you can take a trade hoping it will come back the other way.

Where would you go wrong? If the stock has closed below the trend line for several weeks. In the table above, this only happened once. The point with all of these strategies is that you don’t have to limit yourself when stocks are stuck in a range. You can simply adapt to market conditions and keep an eye on when they change, because they always will.

Enjoy your day,
Keith Kaplan
CEO, CommerceSmith

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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