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. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  2. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  3. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  4. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  5. Term

    What is Pegging?

    Pegging refers to the practice of fixing one country's currency to that of another country. It also describes a practice in which investors avoid purchasing security shares underlying a put option.
  6. Home & Auto

    Understanding Pre-Qualification Vs. Pre-Approval

    Contrary to popular belief, being pre-qualified for a mortgage doesn’t mean you’re pre-approved for a home loan.
  7. Investing Basics

    An Introduction To Structured Products

    Structured products take a traditional security and replace its usual payment features with a non-traditional payoff.
  8. Options & Futures

    Contango Versus Normal Backwardation

    It’s important for both hedgers and speculators to know whether the commodity futures markets are in contango or normal backwardation.
  9. Investing Basics

    What Does Contango Mean?

    Contango​ is when the futures price of a commodity is higher than the expected future spot price.
  10. Options & Futures

    The Short Guide To Insure Stock Market Losses

    The best ways to hedge against losses are to diversify your portfolio and to use a variety of options.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  3. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  4. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  5. Can mutual funds invest in options and futures? (RYMBX, GATEX)

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  6. 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 >>
Hot Definitions
  1. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  4. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  5. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
Trading Center