We have Russia annexing Crimea from Ukraine and interest rates set to float higher sometime in early 2015, but the S&P 500 continued to edge up to another record-high on Friday.
Federal Reserve Chair Janet Yellen is continuing to pull back on the quantitative easing that the former chair, Ben Bernanke, put in place. By year-end, the bond buying will likely be eliminated as the central bank allows the economy to try to stand on its own two feet. Of course, if everything goes well, Yellen also plans to begin ratcheting up interest rates as soon as early 2015. This could impact the stock market.
The upward move in interest rates and the elimination of quantitative easing means the easy money that had been pumped into the economy by the Federal Reserve will come to an end. This is concerning for the stock market, as the easy money has largely been the key reason why we are in the fifth year of this superlative bull stock market.
While it’s enticing to sit on all of the gains achieved so far, you should also be conscious of the profits made and should look at several risk management strategies.
The most important lesson is to take some money off the table and avoid soaking a possible downdraft in the stock market that could severely reduce your gains.
Making sure you have an exit strategy is paramount at this time.
I fully expect another downside move in the stock market sometime in the upcoming quarters. (Read “Stock Market Setting Up for Its Next ‘Fire Sale’?”)
You can also set a realistic price target for a stock and exit or take some profits when the stock price reaches that target. As I said, make sure you are realistic about the target; don’t convince yourself that the price of the stock is worth much more than it really is.
And if you are riding on some massive stock market gains—by which I mean over 100%—I suggest taking profits on a portion of the position and letting the remaining portion ride. For example, say your position is up 100% or more; a viable investment strategy would be to sell 50% of the position and keep the remaining 50%. This strategy means you effectively create a zero-cost trade, since you’ve recouped your initial investment. Ride the remaining 50% stake as risk-capital.
What’s important to realize is to not be too greedy during the upswings in the stock market and constantly be on the lookout to absorb some profits.