Long-term investors believe in stock market future. It makes little difference whether the feel-good feeling derives from patriotism, past stock market experience, or the rumbling of famous names in the investment world. Hence, you need to highlight that the dollars they spend are still at work.
Traders and investors in the short term do not think so. We don’t have the luxury of buying into falls in the market and they don’t know if the markets will be priced in many years from now. Therefore, the notion of “buying the dip” is not in their investment strategy arsenal – unless they get a clear buy signal from one of their technical indicators.
When the Market is Falling
If you’re a typical, optimistic, long-term investor who doesn’t seek to guess what’s to come next, and if you have cash saved for a buying opportunity, then the best plan is to invest some of that capital now and spend even more capital — if and when the market starts to decline.
You need to remember two key points. First, don’t borrow money to invest. Do not use money within 6 months which will be required for some other reason. Just use the cash allocated to invest. Second, learn how to use options so you can secure your portfolio against a costly loss while at the same time staying bullish.
Replace Stock With In-The-Money Call Options
What you will lose if the market tumbles is the premium charged for the call options. If you want to reinvest in a stock and once you want, then you have a choice.
Take an example, you own 300 shares of XYZ, currently priced near $58 per share. Notice that the stock fell from $58 to $48, and you lost just the expense of the right to call. Other shareholders have lost $10 each.
When the downturn in the market comes to an end and the rallies in the market then you will have complete leverage of 300 XYZ shares. You get to participate in the rally no matter how big the stock rallies are. The only cost (the future advantage you failed to earn) is the call option time premium.
If you paid $5 for that call the intrinsic value is $3 ($58 stock price minus $55 strike price) and the time value is $2. You’ll have missed the chance to gain an extra $2 per share — but in exchange, you’ve been saved from a massive loss and participated in the rally. It will be quite a good deal.
