Given that we don’t want to predict but react instead – as per command$3 – we need to do scenario planning. With the market it is easy to know which scenarios to plan for, because the market can only go up, down or sideways. In fact the market will go up, down and sideways. So the real question is in what time frame will the market go up, down or sideways.
If you have a traditional buy & hold trading strategy, then there is little point in making these scenarios because your strategy is basically to wait if the market goes sideways, buy more stocks if the market goes down and wait if the market rises.
We on the other hand use a non-traditional buy & hold strategy using puts and calls. For us it is important to foresee what the market will do in the next couple of months or so. If we foresee that the market is going to rise, we sell puts and cover our covered calls. If we foresee the market to go sideways, we wait and make a profit due to our sold puts and options becoming cheaper to buy back. If we foresee the market to drop in the coming months, we sell covered calls and cover our sold puts.
For day trading, if we foresee the market rising for the coming 30 minutes we buy calls and if we foresee the market dropping for the coming 30 minutes we buy puts. Otherwise we don’t do anything.
Besides doing scenario planning for whether the market goes up, down or sideways, we also use scenario planning to determine what kind of stocks to buy given the economic circumstances. Which sectors do well in a recession and which sectors do well when the economy does well.