A correction in world stock prices is in progress as selling capitulation is evident. In U.S. markets, the technology sector has been hit especially hard, down over 6% during the recent selling. Recently, markets in Turkey fell over 8% while emerging markets in Brazil and Mexico gave up over 4%. In Asia, we are also seeing losses mounting in Japan and the little tigers.
While the selling continues, you need to focus on risk management. This is something that I always emphasize and should have been in place prior to the selling. To protect against the downside risk, you only need to adopt some simple strategies that will help protect profits.
The standard strategy is setting stop-loss limits on your stocks. The degree of loss you are wiling to assume depends largely on your personal comfort level. Setting a stop-loss too close to the prevailing stock price could result in the early liquidation of the stock during a minor sell-off, but then, if the loss is what you feel comfortable with then it is fine for you. The idea behind stop-loss limits is to preserve your capital in the case you had made a mistake, which we all do.
Another strategy that I like when markets are surging is the use of put options. You can buy put options to match against an individual stock if you happen to have a large position in a particular stock. Conversely, you can also buy a put option on an index that closely mirrors your portfolio composition. For instance, if your portfolio is weighted towards technology stocks, you could buy a put option on the NASDAQ 100. If you are a large-cap investor, you can protect yourself via put options on the Dow Industrial or S&P 500 if the portfolio is broadly based.
Whatever is the case, buying put options as a Protective Hedge makes sense and is akin to buying insurance on your home or automobile
The bottom line is you need to adopt risk management strategies at all times and especially when stocks may be peaking as they were several weeks ago.