Imagine letting a losing trade run, and before you even realize it, the position is down 20%, 30%, or more. Your $10.00 stock declined 30% to $7.00; you decide to hold the position, hoping for a rebound, but deep down you know the stock would need to rally more than 40% just for you to break even. Clearly, it’s not easy when a stock falls to greater depths.
But that’s why you should take the opportunity to dump losers when the stock market rallies, as is the case at this time. Avoiding a loss is just as good as making profits.
As many of you know, I believe the stock market is vulnerable to some selling and a stock market correction, based on my technical analysis of the charts. The S&P 500 is fighting resistance to advance higher, and the Dow Jones Industrial Average, while setting anther record-high on Monday, continues to show the potential of a stock market correction of at least six percent.
Think about how the stock market has moved to these levels. The easy money policy pushed by the Federal Reserve has been a key driving force behind this four-year run-up. But now, with the Fed expected to begin tapering in December or early 2014, the focus will shift to the economy and corporate revenue growth—which aren’t so stellar. In fact, in both cases, they’re flat.
Even the surge in the initial public offering (IPO) market is a red flag in my view. When I see an IPO double on its first day, it reminds me of the euphoria that I witnessed in late 1999, just prior to the stock market’s implosion. (Read “2013 IPO Frenzy an Omen for the Stock Market?”) I’m not saying it’s going to be the same this time around, but you need to be on guard. The NASDAQ traded above 5,000 at its height in 2000. Now 13 years later, the index—despite being up over 30% this year—is still more than 20% from its high.
While taking some profits off the table prior to the year-end always makes sense, I also understand why you’d be hesitant to do so, given the recent gains.
As an alternative to selling, you can always buy put options as a hedge against stock market weakness. I’m a big believer in hedging the risk; you should be, too.
Whether you have a few stocks or many, there’s always a hedge you can put together. From small-cap stocks to big-cap stocks, there are many put options available.
The majority of S&P 500 and Dow Jones industrial stocks have put options to buy. If you are heavily invested in the technology sector, you can buy the put options for the NASDAQ 100 or even for specific areas of the technology sector.
For investors, the key to a good investment strategy is to make sure you have some put options in place, just in case the stock market corrects—and trust me: it will.