Although timing the market is futile, there are strategies for protecting a portfolio when the market is volatile. This investment philosophy centers on helping investors prepare for the next bear market.
Among the strategies employed, placing stop loss levels and adjusting them regularly are of the highest priority. Technical analysis helps reveal breakdowns of certain patterns, as well as violations of trend lines and moving averages. These factors should be tracked on a daily basis. (For more, see: How to Avoid Common Investing Problems.)
The Value of Your Portfolio Will Decline: It's Unavoidable
No one likes to see the value of their portfolio decline. This is unavoidable and part of the norm for the everyday long-term investor. Taking the downside is part of having tolerance for risk. The benefit is the potential reward, which is the growth of the value in time. Managing a portfolio for a slow and steady climb is an arduous task. But it is one of the utmost importance. A long term-investor benefits by losing less during a market down cycle.
A simple hypothetical example we use suggests if you were to have an option of two different portfolios over the next two years, which would you select? Portfolio A, that is up 100% in year one, then down 50% in year two? Or Portfolio B that is up 10% in that same year one and down 5% in year two? Using a starting value of $1, I’ll let you do the math. Which portfolio would select knowing the returns the next two years?
Have An Exit Plan for Every Purchase
Selecting an investment that turns out to be a “winner” begins with a thorough research process. Even with all the stars aligned, an investment can go south at any given moment. So even after what we feel is a good preparation process, you must start with an exit plan in mind at the onset of every purchase.
The “stop level” is usually a price that is up to 7%-10% below the purchase price and represents the point at which an investment could most likely continue much lower. This value should be monitored every day and adjusted higher if the price of the investment were to rise (also known as a trailing stop price). Also, follow the trend (direction) of each investment and use pattern analysis to determine if price levels would violate valid chart patterns. When this happens, it’s often a sign that the risk to hold the security has exceeded the tolerance to hold it. (For more, see: What Is Your Risk Tolerance?)
Also, mathematics as in the example above is our friend (Did you pick B, the better result?). A good rule of thumb is to follow the moving averages of the past price of at least three different time frames. If these values are violated or lines cross in a negative fashion, it is a sign to consider removing the holding from the portfolio.
This example of the Dow Jones Industrial Average from October 2015 shows the violation of numerous technical indicators. At points:
1. A descending triangle pattern bounded by the red and green line projects a further downside move.
2. The 200 day exponential moving average dotted green line is violated.
3. Here, a long-term support line (horizontal dark blue line) and a strong uptrend line in blue at the same time are violated.
4. A rising flag pattern is a sign of caution. A potential downside target is near the 15,000 Dow level due to the pattern height.
Managing your portfolio while tracking these various indicators provides the ongoing information necessary to knowing how to protect the downside that comes with a potential market correction or worst yet - the bear around the corner. (For more from this author, see: Selling a Stock: When Is the Right Time?)
Disclosure: Past performance may not be indicative of future results. No current or prospective client should assume that the future performance of any specific investment, investment strategy (including investments and/or investment strategies recommended by the adviser), will be equal to past performance levels. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will l either be suitable or profitable for a client's investment portfolio. The information presented herein is intended for educational purposes only, and is in no way intended to be interpreted as investment advice. In considering the information presented, readers should consult their own professional advisers, as there is no substitute for personalized investment or tax advice. Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Econ Wealth Management. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.