How to Manage Corrections in the Markets
Volatility is back in the markets and corrections seem to be happening more frequently this year. There’s been a flurry of activity early on this year with rising oil prices, a new Fed chairman, tariffs, and a possible trade war. The eight-plus-year long bull run may be facing its last days, or it might just be a temporary correction before heading even higher.
Whatever fate lies in store for the markets this year, investors need a plan to avoid making critical mistakes. Panic is the biggest enemy for investors. When stocks are plummeting, the knee-jerk response may be to sell and get out, but keeping calm could be the key to maintaining profits.
Portfolio defense 101
Protecting your portfolio against sudden unexpected downturns is a must if you want to maintain healthy long-term returns. Down markets can be scary, but having the right strategy in place can help you weather any storm.
Regardless of how the market is performing, investors should focus on fundamentals rather than technical trading patterns. The intrinsic value of a company remains the same whether it’s in a bull market or bear market. By focusing on things like financial statements and company growth, you can avoid short-term trends and market fads.
Another good defense against downturns is making sure your portfolio allocation is correct. The mixture of stocks and bonds tends to get off track over time because stocks rise more than bonds. A portfolio originally set up as 60% stocks and 40% bonds can turn into 70% or 80% stocks in a few years if left unchecked and subject you to more risk than you want.
Finally, options are a great way to mitigate risk. Simple strategies like covered calls or hedging against a position buy a put help minimize losses. A covered call involves selling a call on a stock you already own. You’ll miss out on larger-than-expected upsides but still keep some profit. More importantly, you’ll get upfront profits from selling the call that helps mitigate losses potentially seen on the stock itself. In the case of a put, the profit gained from a falling stock below the put’s strike price will limit the downside risk to the difference between the price of the stock when you purchased it and the strike price of the put.
One of the most important rules for investing is to remain calm even in the midst of a market panic. Those that panic don’t make good decisions and many savvy investors such as Warren Buffet buy and make big moves in the markets when a sell-off is underway.
When the markets dip 10% or more, you might be tempted to sell out of your positions and wait on the sidelines until the danger is over. But all this strategy does is guarantee the loss already sustained and could prevent you from profiting from the rebound. In other words, stay invested for the long term and don’t stress over temporary downturns in the markets.