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How to Profit from a Market Correction: Diversified Trading Strategies

Aug 17, 2007
What happened to the stock markets these past two weeks?

Anyone at all involved in investing or trading no doubt personally experienced it- the stock markets went through a major correction! And in these days of the "World Economy" such a correction can be triggered by news from anywhere in the world. As it did this time. Poor economic news from China prompted a sharp world decline in stock prices in just a few days.

And many investors, especially long term investors made big losses.

And they're probably asking:
"Is there some way I could have avoided making losses during that period?"
Well, the answer is absolutely Yes.

Obviously trying to predict such a correction and get out before it happens is extremely difficult, and honestly more a matter of luck than anything else.
But by diversifying your trading strategies you can definitely avoid losses during such times - and in fact make healthy profits instead!

The key is to employ a mix of trading techniques that take advantage of a variety of trading timeframes.
Avoid putting all your eggs in the "long term" basket and look at complementing your trading with styles that make returns over the shorter term as well:

- Swing trading is an excellent way to capitalize on market movements over a period of just a few days or weeks.
- Day trading of course, allows you to make returns on stock movements within just one day.
And, mix up how and what you trade:
- Include Short Selling in your trading techniques. By selling a stock or index short, you are looking to profit from downward moves. This is just as valid as trying to buy low and sell high. And offers an important hedge against a market correction
- Also, there are now Inverse and even Double-Inverse indices that can be traded quite easily. DOG is the symbol for the Inverse Dow 30 Index and DXD is the Double Inverse Dow 30. By owning these, you are essentially short selling the major stock indices.
And, contrary to popular belief, it is not difficult to begin trading in this manner.

Over the years online trading has exploded in popularity and, as a result, the resources, tools, strategies and infrastructure available to the ordinary investor have become enormous.

- Online brokers offer trading accounts with extremely low commissions that allow investors to trade all kinds of different instruments (stocks, options, futures, forex) over all kinds of different timeframes (day trading, swing trading, long term trading).
- A large number of trading strategies and systems are also available online. And many such systems, offer a spectrum of short term and longer term strategies in a single service.
- And online trading platforms have become very sophisticated, offering complex analysis tools and even the ability to develop and back test trading strategies.

So, what simple steps can you take to profit during rising markets AND market corrections?

- Long Term trading: Allocate a portion of your trading funds to long term investments (over many months). Make your profits from the overall market trends - remember to take those profits periodically so that you're not caught by a sudden downturn. And look to include some of those Inverse Indices in your portfolio. They can act as a tremendous hedge against market corrections.

- Medium Term trading: Allocate a portion of your trading funds to Swing Trading. In this way you capitalize on the medium term trends in the markets or individual stocks. Practically all financial instruments go through these medium term swings as traders are constantly trying to determine the right longer term price by buying and selling at support and resistance levels. And by taking both Long and Short trades on these swings you stand to profit in both directions!

- Short Term trading: Allocate a portion of your trading funds to Day Trading. This allows you to completely take the longer term market factors out of the equation. By trading within a single day, it really doesn't matter that there was a long term correction. You profit anyway. With the right strategy, you would undoubtedly recognize the selling opportunity presented on the day(s) when there is a market correction. And by selling short you stand to make enormous gains that day!

- Ask your broker how to set up an account that allows you do trade in this way. You'll be surprised at how simple it can be to get setup.

Much is written about diversifying your investments. But don't just look at diversifying your holdings. Diversify your trading strategies too.
About the Author
Richard Cochrane is an investor, trader and educator on stock and options trading, with a focus on day trading and swing trading strategies for investors. For more information on successful stocks and options trading techniques visit http://www.intradaytrades.com
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