Trading When Markets Go Haywire

Summary Points

• Establishing parameters for trading activity may be beneficial during periods of market volatility.
• Using stop orders may help to avoid outsized losses.
• Resizing your positions, engaging more often with smaller contract size, and adopting options strategies that take advantage of elevated volatilities may be viable approaches.

Periods of heightened market volatility often prompt traders to reassess their risk tolerance and trading strategies. If you have been wondering how to respond to the stock market's recent ups and downs, the following tips may be worth considering:

• Make a Plan. Setting parameters for your trading activity could reduce the chances that emotions will take over when the stock market has a bad day. These parameters could include entry points, exit points, the size of your financial commitment to a given security, and your willingness to hold positions overnight.
• Set Limits on Losses. Decide ahead of time the maximum that you are willing to lose on a position. If you lose the maximum, close your position and don't look back. You may want to consider stop orders, which permit you to set a floor at a particular price and will activate only if there is a drop below that price. Typical baseline prices for stop orders include purchase price, intraday high or low, or breakout support numbers. Stop orders may be used for almost any security, including equities, bonds, shares in exchange-traded funds, options, and others.
• Reevaluate Existing Stop Orders. Thresholds for existing stop orders need to be examined periodically during periods of extreme market volatility. A trigger price that is too close to the current trading range can be activated by daily volatility before market trends assert themselves. This situation can cause unnecessary sales and boost transaction costs significantly.
• Consider Position Sizing. Rather than purchasing 900 shares, it may make sense to purchase 300 shares at three different prices, using volatility to get a better price on each purchase and allowing you to assess in each case if that is the position you actually want. This also allows you to engage with the market more often, which will ultimately help give you a better understanding of the products you trade. Think of it like golfing, if you only swing occasionally, it may be rougher than those that swing the club more often.
• Consider Put Options as a Hedging Strategy. Purchasing a put option permits a buyer to sell a given number of shares of stock at a contracted exercise (strike) price. If the price of the stock rises, the buyer's loss is limited to the cost of the put option. If the stock declines, you can put the stock to someone else at the strike price or sell the put and realize the profit. This uses much less money or margin than shorting a stock without the associated risks. Options trading involves risk, and it is important to make sure you have a solid understanding of options before trading these securities regularly.

There may be other approaches unique to your situation, but the suggestions presented here may help you deal with volatility over time. As you implement tactics that you prefer, be sure to do so with your risk tolerance in mind.

Amerivest Portfolios is an investment advisory service of Amerivest Investment Management, LLC (Amerivest), a registered investment advisor. Brokerage services provided by TD Ameritrade, Inc. TD Ameritrade, Inc. and Amerivest Investment Management, LLX are both wholly owned subsidiaries of TD Ameritrade Holding Corporation. Amerivest is a trademark of TD Ameritrade IP Company, Inc. Amerivest provides nondiscretionary and discretionary advisory services for a fee. Risks applicable to any portfolio are those associated with its underlying securities. For more information, please see the Amerivest Disclosure Brochure (ADV Part 2 http:www.tdameritrade.com/forms/TDA4855.pdf).