2012 has been kind to investors. The S&P 500 is up nearly 7% since the beginning of the year, equaling the gain that some forecasters believed would take a year to achieve. Many think the market will continue to rise during the first quarter of 2012, but for those who consider themselves short- to medium-term traders, they know that the market has a way of taking back what it gives so freely, virtually overnight.

This is why investors are happy to see the market rise, but they know that they can't get complacent. When the market continues to go up, what should an investor or trader do to both protect their gains but not lose out on further upside? Here are a few ideas.

SEE: Digging Deeper Into Bull And Bear Markets

Trailing Stops
When a trade is working and money is being made, the trailing stop is one of the best tools the trader can use. As the price of a stock rises, the trailing stop is automatically adjusted to stay a certain distance below the current price. Let's assume that you want to sell your $30 stock if it falls 2% from its current level. If you set a regular stop order at 2% below the current price or $29.40, the stock would remain at $29.40 even as the stock goes higher. A trailing stop would remain at 2% below the stock as it rose. It wouldn't adjust when the stock price falls so you're sure that your maximum loss would always be 2% below the highest price.

Reverse Dollar Cost Averaging
It's impossible to time the market, so trying to find the top of an upward move in order to sell your entire position will likely be a losing strategy. Instead, when you believe your stock is near the top of its upward move, sell a portion of your position. If it continues to move higher, sell another portion at a certain price. Don't be an all-or-nothing investor. You'll likely make less money than if you dollar cost average as a seller as well as a buyer.

Adjust Your Weighting
Professional investors are rarely 100% long in their investments. By using inverse ETFs like ProShares UltraShort S&P500 (SDS), shorting of stock, currency trades and other "short" trades, investors are able to protect themselves as the market rises. Some investors may call this "fading the rally."

Even in the best of markets, short or medium term traders are rarely 100% long the market and as the market goes higher, they may reduce their long exposure to less than 70%. Every trader has different strategies but as the market rises, consider changing your weighting. Selling stock can trigger hefty tax penalties, so opening short positions against your current stock may be a more tax advantageous strategy.

Put Options
When the market moves up, the price of hedging gets increasingly cheaper. Remember that $30 stock you owned? Purchase a put option at a strike price below the stock's current price to insure your losses. If you purchase a $29 put option, you can purchase 100 shares at $29 if the stock goes below the $29 strike price. This insures the stock position you already own, making the maximum loss $29 and possibly an appreciable gain on your put option if the stock continues to drop in value. The best thing about a put option is that it's cheap insurance and as the market rises, put options generally get cheaper.

Increase Your Cash
Don't be greedy. If you've made a lot of money as the market has gone up, don't feel bad about taking your profits. It's always better to make a little less money instead of losing a lot when the market decides to go down. Increasing your cash will set you up to repurchase at discount prices once the market does correct.

The Bottom Line
It's easy to believe that the market will continue to rise but if history is a guide, mean reversion will eventually kick in and the market will correct. If you're a trader, be ready for the mean reversion by protecting yourself. If you're a long term investor, don't react to the short-term corrections – stay invested and buy when the market is once again value priced.

Related Articles
  1. Home & Auto

    Understanding Rent-to-Own Contracts

    They can work for you or against you. Here's how to negotiate a fair one.
  2. Home & Auto

    Avoiding the 5 Most Common Rent-to-Own Mistakes

    Pitfalls that a prospective tenant-buyer could encounter on the road to purchase – and how not to stumble into them.
  3. Home & Auto

    Renting vs. Owning: Which is Better for You?

    Despite the conventional wisdom, renting might make more financial sense than you think.
  4. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  5. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  6. Investing

    6 Reasons Why Every Investor Should Consider ETFs

    Once you understand the benefits of ETFs, you’ll see how they could be an exciting and smart way to help meet your financial goals. Here some key facts.
  7. Home & Auto

    When Getting a Rent-to-Own Car Makes Sense

    If your credit is bad, rent-to-own may be a better way to purchase a car than taking out a subprime loan – or it may not be. Get out your calculator.
  8. Brokers

    Explaining Market Orders

    A market order is the most common order used to purchase a financial security.
  9. Options & Futures

    An Introduction To Value at Risk (VAR)

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  10. Investing

    Looking To Begin Trading In The Stock Market?

    If you are a new trader, we explain the differences between penny stocks and options so you can make the best decision for your personal trade plan.
RELATED TERMS
  1. Theta

    A measure of the rate of decline in the value of an option due ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Security

    A financial instrument that represents an ownership position ...
  4. Series 6

    A securities license entitling the holder to register as a limited ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  6. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
RELATED FAQS
  1. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  2. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  3. How do I set a strike price in foreign exchange trading?

    In trading with a foreign exchange, a trader can set a strike price for a currency pair by entering a limit order or a stop ... Read Full Answer >>
  4. How do I place a buy limit order if I want to buy a stock during an initial public ...

    During an initial public offering, or IPO, a trader may place a buy limit order by choosing "Buy" and "Limit" in the order ... Read Full Answer >>
  5. What are the main risks associated with trading derivatives?

    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>
  6. How can an investor profit from a fall in the utilities sector?

    The utilities sector exhibits a high degree of stability compared to the broader market. This makes it best-suited for buy-and-hold ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!