Survive the Next Sell Off in Five Easy Steps

“I never ask if the market is going to go up or down, because I don’t know.”

So said the late, great Sir John Templeton in Forbes back in 1978.

Yet many investors today constantly try to predict what the market is going to do next, or fret about a possible downturn.

Please don’t be one of them.

The truth is, nobody can predict the market’s future with any certainty… even if they tell you they can.

What is certain, however, is that uncertainty rules.

Investors are troubled that the current bull market has lasted too long. And mounting uncertainty over another Greek bailout is only exacerbating their anxiety.

We also know that the stock market is cyclical, so another downturn is inevitable. The problem is knowing precisely when it will hit – and that makes retreating into cash at the slightest hint of weakness the worst possible strategy.

Why? Because if our timing is wrong, we’ll miss out on more profits.

My advice?

In a World Without Crystal Balls, Here’s How to Invest…

If you’re getting jittery, forget about cashing out and instead make some (or all) of these five simple moves:

~ Safety Move #1: Diversify Broadly
If stocks stumble, not every investment will follow suit. Even during the nasty 2008 collapse, several investments rallied, including gold, Treasury bonds, international bonds and the U.S. dollar. So don’t limit your investmnets to just U.S. Stocks. Instead, spread your bets across many investments – including, inflation-protected bonds, international stocks, commodities and emerging markets – to soften the blow of a stock market sell off.

(Please note I said “soften.” Diversification isn’t a perfect hedge. But it does beat being overinvested in a single stock or asset class and losing it all.)

~ Safety Move #2: Sell Short Fundamentally Flawed Companies
If stocks suffer a prolonged sell off, it stands to reason that the companies with the weakest fundamentals will get hit the hardest. So zero in on some truly underwhelming companies.

How? Look for the opposite of what you look for in a potential long positions. Like rapidly declining profits and marketshare, cash-poor balance sheets and products in danger of becoming obsolete… and so forth.

We’ve shared a few possible short ideas here, including OpenTable, FXCM Inc. and GAIN Capital. And I assure you that other compelling short opportunities exist if you’re willing to put in the time to look.

~ Safety Move #3: Buy An Inverse Fund
If you’re uncomfortable selling stocks short, or don’t have the time to research viable stocks, dozens of inverse mutual funds and exchange-traded funds (ETFs) now exist that rise when stocks drop. You can purchase these funds in retirement accounts, too. ProShares, Rydex and Direxion offer the most popular and liquid funds. Just stay away from the double- and triple-leveraged funds.

~ Safety Move #4: Use Trailing Stops Between 15% and 25%
Most investors don’t have a disciplined exit strategy. In fact, a Bloomberg study of 88,000 investors found that the average person is one-and-a-half times more likely to sell a winning stock than a losing one.

That’s where trailing stops come in. They take the guesswork out of selling, thus limiting losses and maximizing profits.

The real advantage of trailing stops, however, is that they prevent us from exiting a stock too early and missing out on profits. Go with a 15% trailing stop if you’re a chronic worrywart. Otherwise, a 25% trailing stop is sufficient.

~ Safety Move #5: Purchase Put Options
If you’re sitting on large stock profits, consider buying enough put option contracts to cover your position. (Remember, one option contract controls 100 shares.) Since a put option gives us the right to sell a stock for a pre-determined price, this move essentially lets us lock in our sale price in the event of a stock market crash.

If stocks continue to march higher, we’ll only lose whatever it cost to buy the put options. But relatively speaking, it’s a cheap price to pay for insurance and to protect profits.

No Need to Retreat

In the end, these five simple moves are preferable to waving the white flag and retreating into cash at the first sign of market weakness. Especially since history suggests this bull market could continue.

And the last thing you want is to miss out on more profits, simply because you got a little scared.

Ahead of the tape,

Louis Basenese

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“I never ask if the market is going to go up or down, because I don’t know.” So said the late, great Sir John Templeton in Forbes back in 1978. Yet many investors today constantly try to predict what the market is going to do next, or fret about a possible downturn. Please don’t be...