Whether you’re a bull or a bear, there’s always a narrative you lean on.
For bulls, the markets’ unexpected surge into bull territory and the Fed’s pause on rate hikes are evidence that the worst is clearly over.
And bears are sticking to the high inflation argument and the persistent threat of recession as reasons to stay cautious.
It’s hard to know which narrative to believe… or how to trade.
If you sit on the sidelines, you could miss out on some good opportunities.
But if you jump into the wrong trade, you could easily tear a big hole in your account.
So in these types of situations, there are two concepts we should follow.
First, focus on each potential trade in isolation… and avoid getting caught up in your expectations.
Being opinionated is okay…
Staying opinionated despite the evidence is not.
And second, take profits when you see them. Because a profitable trade can quickly turn into a loser in volatile markets.
So today, let’s look at how I used these principles with The Opportunistic Trader to generate a return of 34% on iShares 20 Plus Year Treasury Bond ETF (TLT).
Overhyped Fears
At the time we entered this trade, debt ceiling negotiations were still in full swing.
News articles peddled fears that the U.S. could default on its debts for the first time in history. That sent 30-year Treasury rates above 4% – returning them to levels from before the Silicon Valley Bank (SVB) collapse.
But these fears were overhyped, and I didn’t see a default on the horizon.
All the same, this environment sent TLT into oversold territory, especially considering its relative value to stocks.
You can see this in TLT’s chart…
At the time of the trade, TLT was sitting close to the 30 handle on its 14-day RSI, meaning it was oversold.
This created a prime setup for TLT to rise as soon as the market’s fears were relieved. So on May 23, we opened up a call option trade on TLT.
And our expectations proved correct…
On May 31, the House agreed to raise the debt ceiling. That was enough to send our call options soaring.
And on June 1, we sold half of our position for a 40% gain.
We knew the nonfarm payroll report was due out the following day. Those numbers looked unpredictable, so it was wise to lock in gains while we had them.
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Know When to Close It Out
The prospect for further gains looked worth a shot, as the market’s attention turned to the Fed’s upcoming rate decision – expected to be a pause.
Yet TLT ground higher at a slower pace than anticipated.
That meant the remaining half of our options started to fight against time decay.
So we didn’t let our expectations of a further rise in TLT blind us.
The chart told us it was time to close out the trade and lock in the rest of our profits. So we sold the remainder on June 26.
Take another look…
That made a blended gain of 34% in about a month.
As always, I want to be clear that we generated this return using options. If we had bought the stock instead, our returns would have been lower.
However, this scenario highlights the importance of using a strong trade setup and of taking our profits when we see them.
That’s how we’ll make money even in volatile markets.
We’re not hunting down huge countermoves. Nor are we trying to work out where a stock is going to be months from now.
Instead, we aim to find stocks that have run too far in one direction and profit whenever they revert to their mean.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict