A colleague mentioned that they overheard someone ranting about the people in the middle east rioting. Apparently this person’s portfolio was taking a beating because of all the uncertainty there. There are many ethical issues at play with this approach. Should we cheer for the dictator to protect our portfolio as well as their power? With the right strategy we can cheer for democracy, delight in the fall of a dictator, and watch our portfolio maintain the status quo or grow even larger.
Don’t Sweat It
If you’re investing for the long run, don’t look at your portfolio! You’ll be like “that guy” who always complains about every little negative mood. Go outside and enjoy the fresh air, read a book, or do something else with your time. You haven’t lost any money until you actually sell.
Defend Your Profits
Using Stop Loss orders in this environment is essential. A Stop Loss is an order to sell if the price of the stock drops to a level you have set. You can use it to lock in profits. If you bought something at $50 and the current price is at $80, you can set a stop loss at $70 to lock in $20 worth of gains. If it suddenly falls from $80 down to $50 you don’t have to do anything. An order to sell at $70 will execute on the way down. Wouldn’t you rather sell at $70, make $20 in profit, and then buy it back again around $50?
Sell Everything
If you think the world is going to end, just sell everything, wait for it to bottom out, and then buy the dip.
Sell Some Things
Pick a few stocks that are doing just OK and would be affected by volatility. Take your small profit on those. Don’t let a small gain turn into a big loss.
Sell a Portion
Besides using Stop Loss orders, you can sell half or a quarter of your portfolio positions to lock in those profits. If things pull back your loss won’t be as big. You can always buy back in if things start going up again.
Hedge The Portfolio
Hedging is a somewhat advanced topic. In general you allocate a certain percentage of your portfolio to some short positions that will lessen the impact of a pull back. Usually this is done using S&P 500 Options or Futures contracts. For example if 100% of your portfolio is long stock, you may decide to sell 30% of your holdings and then take the proceeds to temporarily buy Put Options on the S&P 500 Index or short the S&P 500 Futures. The short positions will gain if the index pulls back which will lighten the impact of losses in the rest of your portfolio. You’ll want to quickly close these short positions out if the market goes up. Individual investors do have the option of selling everything and sitting out a storm, while fund managers usually have to be 100% in the market at all times. The advantage of hedging is that you don’t have to sell everything to minimize risk, which is great if you have a lot of open positions.
Defeating the Dictator
With the proper hedging strategy it is possible to make money while the stock market goes down. Not all stocks will pull back if it is a short term market dip. Some of your positions may continue to go up. If your hedge goes up more than your losing positions have declined you’ve experienced bi-winning, as Charlie Sheen would say. It is possible through troubled times to still have a winning portfolio and delight in the fall of the dictator. That’s having your cake and eating it too. As for the dictators, we don’t want to “let them eat cake” because that would mean that we would have to share.