Wax On. Wax Off.

The Karate Kid appeared on the big screen in 1984, and is still a classic.  Daniel and his family moved from New Jersey to the shores of California, a surfer’s paradise.  Daniel had a rough time acclimating to the culture.  Mr. Miyagi rescued Daniel and began teaching him to defend himself.  Mr. Miyagi is a wise teacher and taught Daniel son many life lessons in addition to karate.  One lesson was the famous scene of wax on, wax off.   I grew up in Southern California where waxing a car is a rite of passage.  A good wax job takes time and is taxing especially on a large car.  Waxing a car is a two-part job: wax on, wax off.   This lesson, along with many more, will help Daniel defend himself.

The stock market has its own version of wax on, wax off and it’s risk on, risk off.  The risk on, risk off commentary is popular among the T.V. elite.  When the market is climbing the risk on trade is in force.  When the market is falling the risk off trade is preferred.   This is like the all you can eat Brazilian restaurants where servers walk by your table with mounds of meat and will stop to carve you a slice if your food button is green.  If your button is red, the server won’t stop.  Wax on, wax off.  Risk on, risk off.  Food on, food off.  It’s all the same.

How do you know if it’s a risk on, or risk off market?  Unfortunately, it’s a hindsight trade.  In hindsight, a risk on trade should’ve been applied to a rising market while a risk off trade would’ve been better in a falling market.  The risk on, risk off trade isn’t a predictive indicator.

In a risk on trade you’ll want to own stocks and the more aggressive the better.  How can you tell if one stock is more aggressive than another?  The first indicator is the stock’s beta.  A beta greater than 1 is what to look for in a stock.  For example, a stock with a beta of 1.2 should move 20% more than the market.  If the stock market is up 10%, your stock should be up 12%.  Another indicator is the relative strength index or RSI.  A high RSI will indicate momentum in your stock.   An RSI above 60 to 65 will indicate solid momentum.  When RSI goes above 70 it may indicate your stock is overbought.  A stock with a high beta and strong RSI will treat you well in a risk on trade.  A seasoned investor can purchase call options to take advantage of the leverage from stock options.[1]

Of course, the party always ends and then the risk off trade is in vogue.  The best way to profit from a risk off trade is to move your equity holdings to cash or purchase U.S. Treasury investments.  Cash and Treasuries won’t lose value in the short term especially during a market meltdown.  The more adventurous trader can short stocks or purchase put options.[2]  These high-risk strategies will profit in a falling market

Trying to time the stock market and apply the risk on, risk off trade is a risky proposition.  A better investment strategy for most investors is to implement the balance on trade.  In a balance on trade you’re applying a diversified investment strategy using an asset allocation strategy.  Your asset allocation should be balanced between stocks, bonds and cash.  A balanced portfolio will be better!

Lesson not just karate only. Lesson for whole life. Whole life have a balance. Everything be better.” – Mr. Miyagi

 

Bill Parrott is the President and CEO of Parrott Wealth Management.  www.parrottwealth.com

January 8, 2017

 

[1] Options involve risk and are not suitable for all investors.

[2] Options involve risk and are not suitable for all investors.  Short selling is an aggressive investment strategy and is not suitable for all investors.

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