As investors and traders, we wish we could constantly be on the right side of the market. Imagine being fully invested when markets are screaming higher, or cash heavy (or short stocks) when the market turns south. It’s a nice thought, isn’t it? By learning how to handle market uncertainty, you will gain the upper hand.
Markets are not efficient. Information is not disseminated to everyone equally. Traders who have the right information at the right time gain an advantage, but most are not so lucky. You could argue that markets are semi-efficient, which would help explain why some traders have an advantage over others. But instead of arguing how unfair this is, I suggest employing a defensive trading strategy.
How to handle market uncertainty
You can counter market uncertainty by taking a defensive posture. Take risks, but do it carefully so you protect yourself. Stepping onto the risk curve is the only way to earn income as a trader. If you always play it safe, you might not earn better than a cash return (which is close to zero). Take bonds, arguably a safe investment. The 10 year Treasury bond currently yields 1.5% – just under half of the rate of inflation. In other words, you’d earn a negative yield.
Trading equities is risky, but it provides an opportunity to make a good return. If you’ve traded the SPX 500 this year with a well-diversified portfolio, you would be up more than 15%. Even with this year’s sharp spike in inflation, you would be way ahead.
But changes are afoot. We will be transitioning into another phase of Fed monetary policy eventually. Opportunities in the equity markets may be fewer.
A tighter Fed policy is a signal to take risk off. That doesn’t mean sell everything and sit on the sidelines, it simply means pay attention to what’s happening, become more defensive, raise some cash and buy index puts as protection so you can live to fight another day.
Markets will drop again some day, just like they did in 2020, 2008 and 2001. If you learn how to handle market uncertainty now, you will withstand the punishing blows.