The October 2011 gains in the stock market have been nothing short of epic, and it's a performance that we haven't seen since 1974. With August of 1932 seeing an incredible 39% gain, October's 10.77% gain doesn't seem quite as impressive, but if you've followed your portfolio balance, you're undoubtedly very happy with what you see.
TUTORIAL: Investing 101

Not all of the October statistics are cause for blind jubilation. Of S&P stocks, 82% are in the overbought territory, and according to Bespoke Investment Group, these overbought conditions often lead to a stock market correction that returns the market to a better balance of supply and demand. Does that mean there is a cause for concern? Maybe, but there are ways to protect your October gains. This article will examine ways we measure and manage risk. (For more, see Measuring And Managing Investment Risk.)

Scale Out
The easiest, and most effective, way to protect your gains is to sell some of your positions. One strategy is to sell an amount equal to your gains, and leave the original amount in the market to profit from further upside.

Buy Protection
Professional money managers protect themselves against loss by purchasing put options against their stock positions. If you have a stock position that is valued at $38 per share, you could purchase one put option per 100 shares, you own, with a strike price of $35. If the stock were to drop below $35, you won't suffer any losses below your strike price.

Write a Covered Call
Similar to a put option, if you own at least 100 shares, you can write a covered call at a strike price above the current price of the stock. Not only do you collect the premium, paid by the seller, if the stock price drops, the value of the call option drops as well. You can buy it back at a lower price, which produces a profit for you. If the stock continues to rise, you may have to sell your covered call at a loss.

Don't Change Your Strategy
Prior to October, your portfolio was probably highly defensive given the volatile nature of the markets. Your portfolio should remain defensive until there is further evidence that the correction will continue. It's ok to allocate a small additional percentage to growth stocks, but an all-in bull market approach remains ill advised.

Don't Trust Europe
Although October saw positive steps forward in the European debt crisis, as we've seen numerous times, over the past year, the situation can turn negative rapidly, as seen with today's announcement of the Greek referendum. There are plenty of good stocks to choose from, so committing money to banks, or other stocks, that have a lot of European exposure is unnecessary.

Don't Get Greedy
The financial media would have you believe that the mark of a successful investor is to match the gains of the S&P 500. A prudent long-term investor will have a mix of stocks, bonds and other products. Each of these asset classes will have different degrees of volatility. When averaged together, your portfolio's overall performance will not equal the S&P 500, and aren't you glad? When the S&P saw double digit losses, in less than a month, your balanced portfolio outperformed the index.

The Bottom Line
The impressive October gains won't seem impressive if you give all of the gains back. If you're a trader with a short-term horizon, now may be the time to take some of the profits. If you're a longer-term investor, consider using your gains to rebalance your portfolio by weighting a little heavier in equities. As a long-term investor, you shouldn't panic when your investments experience short-term movements. (For more, see 10 Tips For The Successful Long-Term Investor.)

Related Articles
  1. Credit & Loans

    Pre-Qualified Vs. Pre-Approved - What's The Difference?

    These terms may sound the same, but they mean very different things for homebuyers.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Insurance

    Cashing in Your Life Insurance Policy

    Tough times call for desperate measures, but is raiding your life insurance policy even worth considering?
  4. Fundamental Analysis

    Using Decision Trees In Finance

    A decision tree provides a comprehensive framework to review the alternative scenarios and consequences a decision may lead to.
  5. Options & Futures

    Understanding The Escrow Process

    Learn the 10 steps that lead up to closing the deal on your new home and taking possession.
  6. Options & Futures

    Terrorism's Effects on Wall Street

    Terrorist activity tends to have a negative impact on the markets, but just how much? Find out how to take cover.
  7. Mutual Funds & ETFs

    Scared By ETF Risks? Try Hegding With ETF Options

    With more ETFs to trade, the risks associated with these investments have grown. To mitigate these risks, ETF options are a hedging strategy for traders.
  8. Mutual Funds & ETFs

    ETF Options Vs Index Options

    Investors have much to consider when they’re deciding between ETF and index options. Here's help in making the decision.
  9. Options & Futures

    How to use Straddle Strategies

    Discover how this sophisticated trading technique can unlock significant gains while reducing your losses.
  10. Options & Futures

    Top 4 Apps for Option Traders

    Discover some of the most popular apps that options traders use so they can stay on top of market opportunities and manage their investments.
  1. 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 >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. 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 >>
  4. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  5. How do I determine the breakeven point for a short put?

    The breakeven point for a short put is the strike price of the option minus the premium. Selling puts is a way for traders ... Read Full Answer >>
  6. What options strategies are best suited for investing in the retail sector?

    Retail is a broad sector whose seven discrete segments all exhibit greater volatility than the broader market. The sector ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  2. Bullish Engulfing Pattern

    A chart pattern that forms when a small black candlestick is followed by a large white candlestick that completely eclipses ...
  3. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  4. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  5. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
Trading Center