In 2011, congress passed a series of laws designed to start to reduce the annual deficit. With the national debt passing $16 Trillion dollars, most of congress agreed that reducing the deficit was important.
However, the Congressional Budget Office, in a recent report, predicted that if the laws are left in tact, there will be a significant recession in 2013, and unemployment will rise from 8% to 9%.
While there is no way to predict what will happen, it does suggest that you should be prepared in your investments to act if the market starts to head south.
But how do you know when to act? There are several indicators that can give you an idea that the market is starting a downturn. My favorites are the 20-day and the 50-day moving averages on the S&P 500 index (SPX). For example, if the 20-day moving average crosses below the 200-day moving average, that’s a sign to start protecting yourself. When the 50-day moving average crosses below the 200-day moving average on the SPX, that is a good sign that we’re heading down.
Does this guaranteed that the SPX will always head down from there? No, of course not. It is simply a good indicator.
If you had used this indicator in the 2000s decade, you would have made a significant profit rather than losing money for the decade.
Once you decide the market is heading down, what should you do?
One way to approach the problem is to define three steps toward protection and then stick to them. The three steps below are not recommendations, they are mearly examples for you to use in developing your plan.
The first step is the “Get Ready” step. In this step, you might increase the amount of cash that you are holding. Moving from a normal 5% allocation to a 25% allocation might be appropriate. If you don’t have a few percent of your portfolio in gold, now would be a good time. For your stocks and mutual funds, be defensive. Go for dividend growth funds rather than aggressive growth funds. By stocks in the Consumer Discretionary sector, or use XLY, the ETF for that sector. By dividend-paying stocks.
The second step is the “Get Set” step. In this step, you might increase your cash and gold allocations further. You might also start to move money into bear ETFs. These funds go up when the market goes down. Funds to consider include SH, the inverse of the S&P 500, DOG, the inverse of the Dow Jones Industrial average, and PSQ, the inverse of the NASDAQ index.
The third step is the “Go” step. In this step, you would further increase your allocations of cash and gold, and increase your exposure to inverse ETFs. For stock that you continue to hold, buy put options to protect them. Look into “collar trades” to further protect your stock holdings. If you want an easier way to protect, look into put options on the SPY ETF. Buy one put option for every $14,000 of unprotected stock that you have.
A key question is when do you get back into the market. Again, use the moving averages on SPX. If the 20-day moving average crosses above the 200-day moving average, it’s time to start moving back into the market. If the 50-day moving average crosses above the 200-day, that’s the time to get fully back into the market.
You don’t have to get sucked in to the buy-and-hold laziness and lose another 40% of your retirement. You can protect yourself.