These are truly crazy times to be a stock market investor!
Intense price swings and spiking volatility have snapped the bulls out of their self-righteousness and have caused the bears to start crawling out of their caves.
The widely followed Dow Jones Industrials has made multiple 1000 points fluctuations worrying even the most seasoned long term investor.
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This volatility has been a God send for short term swing and day traders. After years of low volatility, these short-term market players are embracing and profiting handsomely from the current conditions.
However, most long term investors are extremely concerned about the very real potential for a bear market.
Fortunately, there are a few steps that can be taken by every long term stock investor to help protect your portfolio should conditions shift to a bear market.
First let’s take a look at what is happening.
Stocks have fallen into and out of correction territory multiple times in the last several months.
Every sell off into the correction zone has been matched by an explosive up move as investors and hedge fund super computers go to work snapping up shares at perceived bargain prices.
Another reason for the severe volatility has to do with the actual market structure and regulations themselves.
Lessons learned from the 1987 market crash have created trading circuit breakers which stop trading when the S&P 500 drop by 7%, 13%, and 20% from the previous close. These circuit breakers help prevent a complete market melt-down like we experienced in 1987 from ever happening again. However, it is not impossible, if there is an all out selling assault on the stock market. The circuit breakers will help make the selling orderly, but will not stop a bear market.
What is causing the volatility?
Stocks are being pressured by a trifecta of bearish pressures. Chinese economic fears, rate hike worries, and just plain old profit taking have struck stocks in a full frontal attack.
In fact, recently, things became so worrisome that the New York Stock Exchange invoked Rule 48. Rule 48 doesn’t stop trading, like the circuit breakers, but rather speeds up the opening by appending the regulation that stock prices need to be announced at the market open. Rule 48 allows prices to open without approval of stock market floor managers which prevents delays in opening that will likely result in even more panic selling. This rule has only been used a few times since it was approved by the SEC in 2007 and recently was one of those times.
All professional traders understand that the time to buy is when there is figurative blood in the streets. This fact was witnessed on Monday as the stock market came roaring back 100’s of DJIA points after the steep sell-off. While this is certainly great to see, there is no guarantee that the bears will not continue to wreak their carnage on the stock market.
The upswings are the result of economic stimulus news from China, lessening of rate hike fears, and bullish U.S. economic news. Not to mention, just plain old bargain hunting on a huge scale by hedge funds and institutional money managers.
Interestingly, rallies during bear markets have historically been sharper and more severe than rallies during bull markets. What this means is that should things turn bearish, the high volatility and large swings are here to stay.
As was stated earlier, short term and day traders are loving the newly spiking volatility. However, long term investors are downright fearful of what is to happen next.
There is really no need to be afraid. Bear markets are a natural part of the stock market and happen every so often. There are certain things that you can do to best prepare for the potential bear market right around the corner.
Here Are Five Wise Steps To Prepare For The Possible Bear
- Review Your Cash Holdings
Active investors and even long term investors are always trying to find ways to put their cash to work making money.
I understand what it is like to have cash sitting in the account that isn’t deployed in the market.
The feeling isn’t so good when stocks are in a bull market.
However, as we potentially slip into a bear market, having a stockpile of cash is a very wise thing.
This is due to two factors. First, cash holds its value relatively when the stock market is crashing. Secondly, it takes cash to snap up bear market bargains at steep discounts. This is why it is critical to make certain that you have a certain percentage of cash saved as we enter a possible bearish period.
If you don’t have cash reserves, consider selling a few holdings to raise cash for the future.
- Put On A Hedge
This is how many professional and institutional traders manage to survive down periods in the stock market. Hedging helps to protect your portfolio from downside. Unfortunately, it also acts to limit your upside should the market continue higher.
The good news is that hedging can help protect your long term stock holdings without forcing you to sell them.
The easiest way to hedge your long term portfolio is via short index ETFs. There are both leveraged and unleveraged short index ETFs. While you may get more bang for your buck with a short leveraged ETF should the market plunge, I can only suggest them for very experienced traders for a host of reasons.
Non-leveraged short ETFs are the easiest way to hedge a long term portfolio.
Here are my favorite short index ETF’s:
ProShares Short S&P 500 (NYSE: SH)
ProShares Short QQQ (NYSE: PSQ)
ProShares Short Dow 30 (NYSE: DOG)
ProShares Short Russell 2000 (NYSE: RWM)
- Review Your Stop Loss Orders
If you are like most long- term investors you have forgotten where you have your stops set, if you have them at all.
Right now is the perfect time to take a close look at all your stock holdings and place stops just in case the bottom falls out of the market.
This will enable you to sleep better at night knowing that should worse come to worse, your capital has protection.
- Consider Going Bottom Fishing
Fishermen understand that the largest fish often lay on the bottom of the lake or ocean. The same thing can be said for the stock market.
The best deals are at deeply discounted prices at the bottom of a stock’s range.
Bottom fishing with limit orders and cash secured puts (we talked about this in a previous article) makes sense after a steep sell-off.
Look for strong stocks from companies with nothing inherently wrong. However, the stock has sold off because the entire market has sold off. These are the ideal bottom fishing plays.
- Cull The Herd
If you are fortunate to be sitting on large profits in one or more stocks in your portfolio, consider taking the profits now.
This culling of your stock herd will free up cash so that you can bottom fish effectively or get ready for the next bull market.
It will also work to increase your confidence as you will see the hard earned profits realized as spendable cash.