It's been nearly six months since the S&P 500 began its precipitous rise, and we have yet to even endure a 5% correction in that time. It might seem as if I'm regularly jumping on the bearish bandwagon, crying "wolf" when nothing seems wrong. But the stock market won't rise forever, and a correction looks inevitable. Therefore, it pays to think ahead. Consider putting a few strategies in motion to protect your portfolio when a market downturn does occur.
Below, I've outlined five approaches that might help you weather the storm. Not every situation works for every individual, but chances are good that at least one of these strategies may make sense to you.
1. Consider gold
Uncertainty is a common cause for a stock market drop, and no commodity tends to respond more positively to the resulting flight to safety than gold. Gold represents a tangible investment that doesn't evaporate during recessionary times -- unlike corporate earnings. Unfortunately, finding investing success within the gold sector can be harder than winning at whack-a-mole, since many of these companies are still in the exploration stages of their existence.
One solution is the SPDR Gold Trust
2. Make puts your friend
You might think that the best way to prepare for a market correction would be to sell stocks short. But as even I've learned, the market can stay irrational longer than you can stay solvent. Shorting a stock leaves you exposed to losses greater than your initial investment, yet offers a maximum return of only 100%. Instead, put options could be your best avenue to downside success. Buying put options risks only your initial investment, and gives you a return potential greater than 100%.
Put options can also provide a hedge against current long positions. Netflix
3. Use your easy button
History has proven that you have a greater return potential if you hold for the long term, as opposed to trying to time the market. Having a well-balanced portfolio could make the difference between enduring a portfolio hiccup or a monetary freefall. To help curb those freefalls, consider investing in low-beta consumer staples stocks.
Consumer staples usually have considerably smaller daily fluctuations, and their businesses often remain consistent even during weak economic times. Two companies that fit this description are Procter & Gamble
4. Follow the money
Although I'd never advocate herd mentality, it does pay to keep an eye on what the most prominent investors are buying. Big investors Warren Buffett, George Soros, and Carl Icahn didn't become billionaires overnight. Time after time, their impeccable ability to analyze businesses has often allowed them to spot trends before many other investors do.
Carl Icahn, for example, recently reported taking a 9% stake in Clorox
5. Be patient
Finally, we come to what may be the most important thing you can do when preparing for a correction: Don't panic when one actually does occur. Your financial hopes and dreams almost certainly won't come crashing down, just because the indexes moved down 10%. Using sound judgment is paramount to your success as an investor.
To reduce your downside exposure, consider using trailing stops. These allow you to determine the level at which your stock will automatically be sold if it begins to head lower. Likewise, in a rising market environment like we're in now, don't be afraid to use limit buy orders, which are well below current prices.
Right now, I have my eye on Alliance Fiber Optic
My point? Don't chase a stock higher. Make the values come to you.
Do you have a particular strategy you employ to protect your profits from corrections that I haven't mentioned? Share your thoughts in the comments section below.