4 Ways To Prepare for a Market Slowdown

 

by Tony Sagami
By Tony Sagami

I feel dumb. Really, really dumb.

Why?

Because I disagree with two of the smartest investment minds I know — my colleagues Mike Larson and Sean Brodrick — about the direction of the stock market.

I give both a lot of credit. They clearly and loudly warned their members that the stock market was headed for trouble before its first-quarter meltdown — the worst quarter since the COVID-19 crash. And people that listened to them would have collectively saved millions of dollars.

Me? I stayed invested and recommended doing the same.

Maybe you think I'm nuts. Hey, I've been called much worse, but if you think stock market trouble is brewing, here are four things you can do:

No 1. Buy, Hold & Pray: If your goals are very long term and you have an iron-lined stomach, you could choose to do nothing and ride out any turbulence. In that case, a do-nothing, buy-and-hold strategy will work for you.

However, if you are NOT prepared to do nothing …

No. 2. Trim Stock Holdings Right Now: From time to time, you should look at how much of your money is allocated to each of the major investment categories — stocks, bonds, gold, real estate, natural resources and others.

Whether or not you keep a formal target, you might consider decreasing your allocation to stocks for peace of mind.

You could then put the proceeds into something super safe like cold, hard cash. Doing this will protect your wealth if the market continues to fall. Plus, you'll have a resource of sidelined cash to buy at lower prices.

The only negative is that money market, certificate of deposit (CD) and Treasury rates are very low.

No. 3. Play Defense: If you want to stay invested as long as possible — but still want to avoid a downturn — you should employ some sort of defensive strategy like market timing or the use of protective stop losses.

To time the market, I personally use momentum and moving averages. They don't help me predict the future. But they sure as heck do a good job of telling me what's going on and helping me discipline my trading.

Protective stop losses are when you set a price — below the current price — at which you'd like your shares to be sold. If the stock falls to or through that price, it will trigger an automatic order to sell the stock at the market.

No. 4. Portfolio Insurance: Depending on how much risk you can handle, one of the first three methods might work for you. However, you can actually profit from falling stock prices.

How? A few methods come to mind …

  • Short Selling. When you buy a stock, you are betting that it will go up. And when you sell a stock "short," you are betting that it will go down.

To short a stock, your broker loans you shares. The shares are sold, and the proceeds are credited to your account. Sooner or later, you must close the short by buying back the same number of shares and returning them to your broker. This is called covering your shorts.

If the price drops, you can buy back the stock at the lower price and make a profit on the difference. Conversely, if the price of the stock rises, you must buy it back at the higher price … and you lose money. Most investors don't have the stomach for that type of reverse pain.

  • Inverse Funds and ETFs. Some mutual funds and exchange-traded funds (ETFs) are designed to profit from falling stock prices.

For example, ProShares Short QQQ (PSQ) is designed to track the inverse of the daily performance of the 100 largest domestic and international non-financial companies listed on the tech-heavy Nasdaq. So, for every 10% the Nasdaq 100 drops, the ETF is meant to go up 10%.

Of course, the opposite can happen: If the index rises 10%, the ETF could drop 10%.

  • Put Options. Investing in put options is a low-cost way to profit from falling prices.

A put option contract gives its owner the right — but not the obligation — to sell a specific number of shares of an underlying stock at a specific price within a specific time.

You can buy put options on everything from Microsoft (MSFT) to Costco (COST) to General Motors (GM).

If the underlying stock's price falls while you own the puts, the value of your options will likely go up significantly.

What happens if the stock goes up? Then your put options could go down in value and potentially expire without being worth anything.

The key is that you can only lose as much as you paid for the options, while your profit potential has no ceiling … which I think makes it the best way to protect your portfolio from a bear market.

Need a Hand?

If you think stock market trouble is brewing, I highly, highly recommend that you take a look at Mike's Safe Money Report and Sean's Wealth Megatrends.

They are two of the best in the business at managing risk and making money while everybody else is losing their shirts. Check them out!

Best wishes,

Tony

About the Editor

Even in the worst years for stocks, Tony was twice named “Portfolio Manager of the Year” by Thomson Financial. He was one of the first to introduce computer software for trading stocks. And in the early 2000s, he wrote “The Supernet,” providing a vision of the future internet that was far ahead of its time.

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