The stock markets experienced an extreme shock last year and it wasn’t the novel coronavirus that caused it. The decision to close the world for business is the source of the global economic devastation. Meanwhile, the honey-badger attitude on Wall Street is propping up stock prices. The bounce from the crash reaction in March was astonishing. In fact, it hasn’t stopped yet because the indices continue setting records. Last week we finally saw some selling but judging by the Wednesday action, the bulls are itching to buy. The appetite for risk is so high that there are still many great stocks to trade, especially after the earnings.
Today we discuss three instances but not all from the same perspective. We suggest rolling out of one and swap it into another. As for the third, we’re going to set up an action plan for the next few weeks. They don’t ring bells to announce perfect entry and exit points, else there would be no reward. That’s why investors need to develop their thesis carefully. Every trade needs to have a reason and goals. I try to imagine every trade like I’m taking it for my mother. If I can’t trust my thesis with her money, then perhaps my conviction is not that good.
Markets have been so strong, but therein lies some risk. Regardless of how good each individual opportunity is, it has to exist inside the collective market. If we suffer a general correction the best thesis is going to also fail. Therefore, it is wise for investors to take smaller risks until we either get more clarity or lose some weight. It is not healthy to have this much fat without shaking some froth out of these indices.
You’ve heard the term cautiously optimistic and it sounds cliché but it’s totally true. I’m concerned to the point where I want to exercise caution. But I’m not bearish enough to outright short stocks. It is not wise to fight the tape, fight the Fed or go against the prevailing themes. We have all of these going on at the same time right now. And this is the strongest Fed we’ve ever had. The actions that they are taking is borderline lunacy. They are conducting an experiment and I hope it ends well. This week the Biden team is pushing for more stimulus and into record debt. We are wading into uncarted waters.
The last time the Fed tried to exit this perpetual stimulus (quantitative easing, or QE) was in 2018 and it ended in a crash. Finally, in December, Fed chair Jerome Powell raised the white flag and announced a 180-degree turn in policy. The day they hint at the possibility of exiting QE the exit doors for stocks won’t be wide enough. There is no way this unwinds in an orderly fashion. We have a preview of it from the taper tantrum when Bernanke tried it. This time the house of cards is even taller. In fact, it’s never been taller.
Here are three great stocks to trade:
Great Stocks to Trade: Spotify (SPOT)
I decided to start with the happy part of today’s note and that’s Spotify stock. The company announced earnings and as a result the stock fell 8% on Wednesday. It wasn’t so much the quality of the earnings report that drove prices lower because they beat their goals. Investors have wrong lofty expectations. Looking at the results we can clearly see the company is still firing on all cylinders. They delivered strong growth and almost 30% expansion of their user metrics.
Clearly they are still growing rapidly and spending money just like before. The reason the stock fell is because the investors wanted to hear extreme exuberance about the future. Managements don’t like to over-promise so I will take my cues from the actual results and their trend. Those have not changed so once this hissy fit ends buyers will come back. There is nothing wrong with the company other than the assumption is that the stock is a little sick.
Catching a falling knife like this makes total sense. Going all in in one day it falls is a little reckless. I would buy the dip with a partial position and leave room to add more later. Another way of doing this is by using options. Investors can sell puts instead of buying the shares on red days. This gets them long the stock with a buffer from current price just in case the selling persists.
The way we consume media has changed for ever and Spotify is right in the middle of it. This is to say that their business is going to continue to be healthy for years. I remember when investors panicked out of the stock because of the competition from Apple (NASDAQ:AAPL). You have to respect the small team that can go toe to toe with that giant and survive. They’ve earned the benefit of the doubt in my book. There is nothing wrong with the company!
I have the opposite sentiment with GOOGL stock. This is definitely not an obvious place to start a bullish position. The easiest mistake to avoid is buying a stock at its all-time high and on a spike. I am very confident that investors will have the opportunity to buy the stock a lot lower. This is not the same as me saying short it. Earlier, I mentioned that this is a strong market, the last thing I need is to fight it. The business is fine and I don’t argue with that. My issue is with the levels of the stock.
If I’m long Alphabet stock I would be booking my profits on the spike. The least I can do is sell covered calls against my shares to hedge the position. Capital would be better deployed buying stocks like Spotify on their dips. There’s a difference between investing and trading. Someone who intends on owning GOOGL for a decade might disagree with me. I prefer to trade around the investments regardless of schedules.
Options can also help here. If I swap out of stock, I can sell puts 20% below current price and generate income from that. This allows me to stay bullish Google with a giant buffer. If price falls then I re-enter at a big discount. This way I can avoid feeling the FOMO because I would still be bullish without the immediate risk.
The situation of the third stock today is in between the other two. I was lucky enough to be long Netflix going into the earnings. And since I practice what I preach, I booked it after the huge 19% spike. Now I can look to re-engage after 12% dip. I’m not saying that this is the bottom. But I am confident for its long-term success and I already have profits in hand. The chart also suggests that there is support lurking close to current prices.
I can develop my thesis to redeploy risk and set my stop loss levels. If NFLX stock drifts lower to the January lows it will find buyers there. Even if that fails, there are more of them through $486 per share. This is what trading is all about, having a thesis and developing a plan. Doing it any other way leaves a lot to chance. Investing is difficult enough as it is. Therefore, I should eliminate as many question marks as possible. I don’t know if Netflix has stopped falling, but I am confident of my methods. I can re-engage long with a partial position now and add to it later.
Here too I can use options to further secure my risk. Instead of buying shares, I can sell puts and create a 20% buffer. You see me mentioning the strategy over and again because it suits my style. I am a planner and selling puts way below current price allows me to set one in motion with clarity.
Regardless of methods, the concept is the same: Buy dips in quality stocks, and take profits after big rallies. Whenever a plan works, rinse and repeat.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.