Why the "TACO Trade" Is a Bad Idea. Do This Instead.

One of the newest trends and acronyms in the investing world among retail investors is the "Trump Always Chickens Out" trade -- also known as TACO. It's built on a belief that President Donald Trump will back off on harsh policies after announcing them and that investors can profit by buying in to stocks at the "right" time as Trump changes his mind and markets react.

Investors point to the pausing and reduction of tariffs as examples of this, with Trump's initial announcements spooking the markets and leading to reduced valuations, before things changed. The idea behind the TACO trade is to buy when that fall happens, since inevitably the president is due to back off from his harsh stances and the market will bounce back.

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I understand the theory, but I think it's flawed and comes with serious risks. Here's why I don't think you should do it and why there is a better strategy to deploy amid market volatility.

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Why the TACO trade could fail miserably

At its core, the TACO trade is a speculative bet on government policy. And betting on any kind of government policy can be risky and unpredictable. What may seem like a sure thing today could appear incredibly unlikely later on.

Just ask cannabis investors of how certain they were in early 2021 (when the Democrats controlled the House and Senate) that marijuana legalization was inevitable. One cannabis company's CEO even said he expected his Canada-based company to be operating in the U.S. in a year. Those hopes didn't pan out -- not by a long shot.

Government policy comes with a lot of red tape and complexity. And while it may seem like we've experienced a predictable pattern of a tough policy announcement followed by a pause or scaling back of those policies, that doesn't mean that it will continue. There's also the risk that rising talk of the TACO trade could embolden the president to take a tougher stance. When he was asked about the acronym, Trump said the person had asked a "nasty question."

S&P 500 returns since Liberation Day data by YCharts

The S&P 500 (SNPINDEX: ^GSPC) has risen by around 6% since "Liberation Day" and the announcement of global and reciprocal tariffs back on April 2. Buying amid that uncertainty and fear would have proven to be a good move. But with the broad index now getting close to its all-time high again, it would take a significant sell-off in the markets to get back to those lows today. Trying to profit from smaller moves in the market can be risky.

It's one thing to bet on a company to perform well and to hit its expectations in an upcoming quarterly earnings report, but it's a far riskier bet to buy or sell stocks based on what the president may do. And by doing so, you could end up in an unenviable position, potentially incurring significant losses if those expectations don't match up to reality.

What investors should do instead

Trying to time the market is a risky endeavor that the world's smartest investors caution against. It makes more sense to create a watch list of stocks you might consider buying if their price drops. Then, set your own price targets -- prices that you think would be cheap for those stocks.

You could put your numbers in a spreadsheet, adding current prices for stocks to see how far away a stock is from your price target. In the event that the market tumbles based on bad news, you can load up on any stocks on your watch list that may have reached your desired price targets. It's important when considering these price targets to build in some margin of safety; it should be a pretty attractive deal rather than just a 5% or 10% drop in price.

Personally, I do this and set aggressive price targets that are near 52-week lows and perhaps even around multiyear lows. With a watch list of stocks and the prices you're willing to pay, you'll be ready to deploy money you have for investing, i.e., that you won't need for several years or to pay regular bills or high-interest debt.

As long as you have a watch list that includes safe, blue chip stocks, this is a strategy which can yield much stronger results in the long run than simply trying to bet on short-term trends and patterns. It will require patience, but by setting up your own watch list and buying when the price for one of your stocks is too cheap to pass up, you can set yourself up for significant gains, which will likely eclipse anything you'll earn in the short run from a speculative TACO trade.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.