One of the hallmarks of a successful investor is to be able to change your bias when the data changes. We are on the cusp of the data possibly changing from bullish to bearish in the stock market.
But the recent market action proves there are cracks in the foundation.
A major tenet of technical analysis is that all data is inherently baked into the price, therefore even heretofore unknown bearish information is being reflected in the market action.
Regardless of your bias, now is the time to seriously consider taking steps to protect your gains from the possible further downside.
Here are three ways to protect your portfolio:
1. Buy Gold
I will be the first to admit that I am far from a gold bug. In fact, I don’t care for the yellow metal in the least. However, adding gold to your investment portfolio makes objective sense during times like these.
Gold has definitely fallen out of favor as an asset class. After hitting $1,900 per ounce in 2011, the traditional inflation hedge price has plunged 35%.
No question we are starting to feel inflationary pressures. The 10-year Treasury yield spiked from 2.9% to over 3.2% just a month ago.
Another apparent potential casualty to raising rates is the real estate market. Fixed rate, 30-year mortgages have jumped over 1% since last year with the average costing 5.05%. Interestingly, this is the highest since 2011.
These changes are painting a bullish picture for gold in the face of stock market uncertainty.
2. Buy Insurance
Believe it or not, there is insurance available that will protect your portfolio from the downside. Make no mistake, this insurance is not free and can be costly. However, in the face of a possible bear market, it may make for a sage move.
The insurance policy allows you to sell your stock at a predetermined price no matter how far the actual price plunges. In other words, someone is required to purchase your shares at a higher price than it would be currently trading after a price drop.
I am talking about buying put options as insurance. Known as “protective puts,” the coverage is acquired by buying one put contract for every 100 shares you own. Each purchased put provides the right to sell the stock at the strike price regardless of how far the stock price drops.
Remember, there is no need to sell the stock at all; this strategy provides merely the ability to do so at the pre-determined price should it help the price drop. The cost of the option is similar to the premium paid for any insurance. You are paying the premium for protection as the puts price. The upside profit for this tactic is unlimited as the stock price can theoretically keep going up. However, it’s important to keep in mind that your profit will be reduced by the premium paid for the Put.
It’s easy to figure out your break-even point for this method. Just add the amount you paid for the put to the price you paid for the stock. Depending on what happens, this can end up being a very insignificant price to pay for the protection provided, particularly during volatile times like today.
3. Sell The Market
One very effective tactic for protecting your gains is to sell the entire market. Selling the market can be done by shorting the index futures, shorting index ETFs or buying inverse index ETFs.
Shorting the DJIA Emini futures represented by the symbol YM or the S&P Emini futures with the symbol ES is a time-tested a way to profit from volatile markets. What happens is your short position climbs in value offsetting losses from your stock portfolio as the market drops.
4. Go To Cash
There is no shame in taking profits and going to cash for as long as needed as the market becomes volatile. Remember, cash is a position and often a very wise position since it enables you to buy stocks at a discount after the shakeout occurs.
Risks To Consider: Every method above is costly, even going to cash, since opportunity cost can be high should the market take off when you are not invested. Always use stops and position size wisely.
Action To Take: Start thinking about instituting one or more of the above tactics to help protect your portfolio.
— David Goodboy
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Source: Street Authority