Some timely words came to mind over the holidays as I thought about the recent volatility in the market.
"Always be in a position to trade another day."
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Who said them? Legendary trader John Bollinger, who developed the Bollinger Band, a technical indicator used by traders to identify when a stock may be overbought or oversold.
Truer words were never spoken. While most investors are so focused on finding the "one big thing" that could change their portfolio forever, they often forget the basics.
Let me put it another way...
One of my investing mentors, in a former life, was an insider deep in the professional poker circuit around the time it started getting more popular online and on television. We're talking about a player with enough talent and experience to hold their own at the table at private games in Texas with billionaire businessmen as well as with multiple World Series of Poker bracelet winners in Vegas.
This person told me, whether it came to poker or investing, "You have to have enough chips to stay in the game."
It makes sense, right? In investing parlance, we call it "capital preservation."
Staying alive is fundamental. Avoiding losses -- especially ones that could end your portfolio -- is step number one.
Today, I'd like to hone in on one of our analysts that's done a better job at this than just about anyone: Amber Hestla, Chief Investment Strategist of Income Trader.
Brad: A lot of our readers are already familiar with your background. You were in the military in a previous life, and today you're a self-taught, award winning trader. Do you think this had any influence on your job today?
Amber: Without question. In military jargon, my job was to "analyze strategic and tactical intelligence about enemy forces and potential battle areas." In plain English, I spent 14 hours a day trying to make sure other soldiers didn't get blown apart by roadside bombs. So the idea of "risk" is always on your mind.
The stakes are a lot less when you're trading. But I think taking an analytical approach to risk carried over to my trading career.
By the time I left the military, I was reading everything I could get my hands on about the market. I sought out the industry's best trading experts for guidance. Soon, I was trading on my own, using tools I developed from the knowledge I had gained, and earning way more than I ever did in the Army.
Brad: You and your subscribers just capped off another great year at Income Trader. Tell us a little about your success.
Amber: What a year it's been... In 2018, we sold 45 put options. Thirty-four of the put options we sold this year expired worthless. (For those who are unfamiliar with options, this is a good thing. It means we got to keep every cent of premium as pure profit.) Of the remaining trades, nine were closed early to lock in profits. None of our put options expired out of the money, which would have assigned us shares.
Of course, we didn't get them all right. For the most part, however, we managed to keep our losses relatively low by closing early -- averaging only -4.8% on our losing positions across the portfolio.
As for gains, well, we had quite a year. Our average annualized return for 2018 was around 35%, significantly better than the S&P 500's 10% loss on the year.
Brad: The numbers for the past 12 months are impressive. But even more impressive is your overall track record. Since the first issue of Income Trader, you've closed 267 positions, and 244 of them have been profitable (a 91% win-rate). What's been the key?
Amber: It all goes back to risk. For starters, the put-selling strategy we use in Income Trader is one of the most conservative options strategies around.
Studies show that 80% of options buyers lose money. So we want to be in the business of selling options, not buying them.
At Income Trader, that means we sell put options. And the best way to reduce risk further is to only sell puts on solid companies you want to own. If you follow this one rule, you're ahead of 99% of options traders.
When you sell a put on a solid performer, you're basically betting that a great company won't fall to fire-sale prices in a short period of time. You receive instant income (known as a premium) from the buyer of the option in return. If the shares remain above what you determine is your dirt-cheap level, you'll keep the premium as 100% profit and never buy one share.
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Brad: And what if you're wrong?
Amber: Once in a while, you may have to buy the shares. But that's not necessarily a bad thing -- after all, you'll be getting a great deal on a stock you'd want to own anyway. The premium you received when you sold the put lowers your cost basis even further. Plus, as you get more comfortable with options, you can then turn around and collect even more income from the stock using a different options strategy (like a covered call).
My goal is to create "no-lose" situations. Of course, there's no such thing in the financial world, but I think selling puts on stocks you want to own is as close as it gets. It's like getting paid to set limit-orders on your favorite stocks.
Brad: What would you say to someone who might be worried about using this strategy when the market is trending down, like it has been lately?
Amber: My basic strategy remains unchanged even in a falling market, but there are some different tactics I use.
Option prices adapt to the market environment, and the premiums on most options should be higher if the market is falling. This is due to the fact that volatility, an important factor in options pricing, should rise in falling markets. And when volatility rises, so do premiums. That means more income for us.
That said, my primary objective is to safely deliver income, and that will require adapting as the market changes. The strategy will remain consistent, but how it's executed it will be determined by the market. Options selling works in any environment, but the best options to use will always be determined by the math.
Brad: Any final thoughts? What are you telling your readers about the market right now.
Amber: As you likely heard over the past few days, the S&P 500 has officially crossed into bear market territory. While this doesn't need to be cause for alarm (bear markets are a normal part of the market cycle), I do believe it's important to not bury our heads in the sand and pretend nothing has changed. As investors, it's crucial to stay informed.
I recently sent my Income Trader subscribers a general roadmap for what I think we can expect in the coming few weeks. It covers some broad trends and a few specific indicators that I'm watching.
Bottom line, just because we're likely looking at a falling stock market doesn't mean our portfolios need to suffer the same fate. A down market will still present a number of short-term trading opportunities. No matter what happens on Wall Street -- or in Washington -- I expect 2019 to be a profitable year for us.
Brad: Thanks again to Amber. On a final note, I'd like to add that as we roll over into a new year, there's never been a better time to try a new strategy like the one Amber uses in Income Trader.
As she mentioned, Amber's options-for-income strategy works in any kind of market -- and it's easy to implement once you set up your brokerage account and acquaint yourself with some basic terminology.
The upside? Well, if you sold 10 contracts on each of Amber's recommended trades in 2018, you'd have collected $20,640 of income. That grows to an amazing $222,213 if you go all the way back to the newsletter's inception. Of course, you don't have to sell 10 contracts (remember: 1 contract controls 100 shares) -- you can adjust the number of contracts based on how much capital you have to trade, which makes Income Trader a great service for a variety of portfolio sizes.