Start the conversation
While the markets did not quite make it to official stock market correction territory this week, the 6% drop in less than a month should have reminded investors that they always need to be prepared for a downturn.
And mind you - despite a rebound today (Friday), this correction may not be over.
We have an almost countless number of negative triggers - from the Ebola virus to the threat of Islamic terrorist attacks - that could strike at any time.
Any one of these triggers could quickly drive the stock market the rest of the way to a 10% correction, or a 15% correction - or worse.
When markets plunge, people get nervous. We're only human. But the worst response to a stock market correction is to let emotions dictate your tactics.
Times like these are why investors need to have a sound, long-term strategy they can rely on to get them through the rough patches. Helping individual investors mold such a strategy is why Money Morning was created.
When it comes to corrections, the first thing you need to know is that stock market downturns are a fact of investing.
"People forget that nothing goes up forever," said Money Morning Chief Investment Strategist Keith Fitz-Gerald, a seasoned market analyst with 33 years of experience.
While that may seem self-evident, many retail investors fail to plan for market corrections. That can lead to a reactive strategy based on emotions, which is OK if you don't mind returns that lag the overall market.
The second big point is investors should not view stock market corrections as a bad thing.
"Reversals are very, very rarely anything more than a short-term adjustment," Fitz-Gerald said. "It usually means many great companies are going on sale."
Rather than dwell on short-term losses, Fitz-Gerald says investors should be looking for opportunities.
"There are a lot of ways you can profit when the markets change direction," he said. "In fact, the menu of choices makes ordering designer coffee seem positively simple."
Here are some of the best ideas we've come up with here at Money Morning to help you survive - and even profit from - a stock market correction...
Stock Market Correction Investing Strategies
Strategy No. 1: Buy Stocks On Sale. The most obvious way to take advantage of a stock market correction is to use it to buy quality stocks on the cheap.
Fitz-Gerald recommends that investors maintain a wish list of stocks they'd like to buy if they were just a little cheaper. A market downturn is the perfect chance to use such a list.
If the stock market correction keeps going, some big names could get a lot more affordable.
"I'd love to see Apple (Nasdaq: AAPL) down at $70 so I can buy it. I'd love to see Tesla (NASDAQ: TSLA) at $200 so people can buy it. I'd love to see Facebook (Nasdaq: FB) at $60 so people could buy it," he said.
Investors should also look for bargains in industries that get beaten up by short-term challenges, but have strong long-term prospects.
Right now, the oil and gas industry fits the bill. The combination of falling oil prices and the plunging market has taken a particularly big bite out of a lot of stocks in this sector.
Fitz-Gerald likes three stocks that figure to rebound in a major way when these two trends reverse. They are: Teekay LNG Partners LP (NYSE: TGP), Northern Tier Energy LP (NYSE: NTI), and Brookfield Asset Management Inc. (NYSE: BAM).
Strategy No. 2: Go Short. Another way to play a stock market downturn is to use short selling.
When you sell a stock short, you borrow the shares from your broker and sell them at the current market price. The idea is to profit by buying the shares back at a lower price once the stock drops. If all goes well, you return the shares to the broker and keep the difference as profit (minus a small margin fee).
"The purest means of profiting from a downward move in the market or an individual stock is by selling short," Fitz-Gerald said. "It's aggressive and it's not for everybody because it can take nerves of steel to bet on failure when the natural human instinct is to bet on success."
But he cautions that investors need to choose the right stock to sell short.
"You don't ever want to bet against a stock solely because it's expensive, or even overvalued," he said. "You want to find some other compelling reason for potential failure or a lower valuation."
As an example, he pointed to the effect of the Ebola scare on the airline industry. That additional risk makes a stock like United Continental Holdings Inc. (NYSE: UAL) a good candidate to short.
Money Morning has more on how to short stocks here.
Strategy No. 3: Profit When an Index Falls. Another basic strategy Fitz-Gerald likes for dealing with a stock market correction - or even a stock market crash - is reverse index funds.
A reverse index fund does just what you'd expect - it rises when the market falls and falls when the market rises. It's essentially a hedge against any downturn.
Fitz-Gerald's favorite here is the Rydex Inverse S&P 500 Strategy Fund (MUTF: RYURX). It's an inverse fund that tracks the S&P 500 and rises 1% for every 1% the index falls.
Another fund that targets the S&P 500 is the ProShares Short S&P 500 ETF (NYSE Arca: SH), which has a lower expense ratio, 0.89% than the Rydex (which has an expense ratio of 1.42%).
One More Thing
Taking advantage of a stock market correction is smart, but preparing your portfolio ahead of time is even smarter.
That means using trailing stops. This tool limits losses, be they from a single lousy earnings report from that company or a stock market crash. Fitz-Gerald recommends setting them at 25%.
Most online trading platforms have stops built in, or you can ask your broker about them.
If the markets rise, you just increase your stops and enjoy the profits. But if the market turns against you, you're protected.
Follow me on Twitter @DavidGZeiler.
UP NEXT: Keith Fitz-Gerald never stops hunting for the best investing strategies to deal with market conditions as they change. Recognizing that interest rates will soon be increasing for the first time in 33 years, Fitz-Gerald shared with Money Morning readers three of the best investments for rising interest rates...
About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.