With both the Nasdaq composite and S&P 500 dropping 10% off their highs, the stock market correction has firmly taken hold. It's the most rapid decline since the Covid crash, and cash is looking like one of the most attractive assets for portfolios right now. But if you're venturing into positions, uncorrelated areas are a good place to start — especially those with a low average true range (ATR) as a measure of volatility. That's what has led us to insurance, international and gold stocks.
The Safe Haven Of Gold Stocks
The attractiveness of the shiny metal isn't something that just materialized in this latest pullback. The SPDR Gold Shares ETF broke out of a decade-long base last year and has trended nicely since then.
As of this writing, our instrument of choice is the VanEck Gold Miners ETF. This collection of gold stocks tends to move with gold, but the moves are a little more than twice as large.
This past month, the gold-stock ETF topped out at 42.66 in mid-February (1). We've given the gold stocks a couple tries this past month. When leading stocks started getting hit we jockeyed positions in GLD, and individual gold stock Agnico-Eagle Mines, a Leaderboard stock, and a leveraged version of GDX, the Direxion Gold Miners 2X Bull ETF (2). But when indexes took a hard hit on Feb. 21, we quickly retreated to all cash by day's end (3).
What To Expect From A Stock Market Correction
We took another venture into GDX on March 5 as it broke a downtrend and surged above its 21-day line with a spectacular relative strength line (4). But as the market took another leg down, we quickly exited, taking profits into strength (5). But then we had another chance.
Gold stocks set up again this past week as GDX crossed above its 42.66 high of last month (1). GDX joined SwingTrader again at 42.67 and we put our stop at 42.07, the low of our entry day (6). Since GDX had an ATR of 3%, our risk was less than half an ATR, or 1.4%.
Improving Your Worst-Case Scenario
At a minimum, GDX should be able to challenge its Oct. 2024 high of 44.22, and that would be a 3.6% gain or a 1.2 ATR move from our entry. Put another way, an easy reward target is 2.6 times more than what we're risking (3.6%/1.4%).
Granted, there is always the chance a position gaps through your stop, a very real and higher risk during a stock market correction. So there is a threat of things going much worse than we expect. But assuming we get our stop, how can we improve our "worst case" scenario? Here's the math on a couple of options:
Scenario 1: Once we get a bit of profit, we can raise our stop. Since our risk was less than 0.5 ATR, once we reached an equivalent profit of roughly 43.25 we could raise our stop to our entry price. We still have all the upside potential of at least 3.6% at minimum, but we could exit the trade flat if it turns on us.
Scenario 2: Take profit once we reach an equivalent level to our risk. This is what we actually did. We locked in profit on half the position at 43.36 on the same day of our entry. Usually we give it at least one day before taking profit. But in a stock market correction we're usually more eager to lock in gains when we have them.
If we still give ourselves to the entry-day low at 42.07, our profit-taking would leave us up slightly on the trade (0.14%) even if we hit our original stop. Our potential profit at 44.22 gets lowered a bit from 3.6% down to 2.7% for our minimum target, but we've increased the likelihood we'll end green.
An Even Better Outcome
We can go one step further. Now that we've locked in some profit, if we raise the stop to our entry, we've got an even better worst-case scenario. If GDX falls to our raised stop, we'll leave with a 0.84% gain on the trade and still have the 2.7% minimum target.
Especially in a market that has increased volatility, locking in profits while you have them makes sense. Taking a partial profit allows you to give up a little on the upside with easy strategies to improve the risk on the downside. You might have to leave some money on the table, but you increase your chances of leaving with some money in your pocket.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
