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At the end of 2014, we predicted that the coming year would be defined by extreme market chaos. Our Capital Wave Strategist Shah Gilani actually called it "the perfect storm of volatility" in his first investor briefing of the year.
Now that volatility is here with a vengeance.
On Monday, the Dow Jones Industrial Average alone dived more than 1,000 points, then surged 900 points... only to drop more than 400 points again. That's a story that repeated itself on indexes worldwide.
The Chicago Board Options Exchange Volatility Index (VIX) surged to a six-year high of 53.29 until volatility swamped the quoting system.
This kind of action can wipe out investors who've gone unprepared against that "perfect storm," but with our Money Morning Editors' favorite protective strategies, you can get your wealth safely through to the shore.
The strategies they're about to share with you will help you do just that...
Keith Fitz-Gerald, Chief Investment Strategist
Whatever the cause of the volatility - the Fed's failure, heavy technical selling now that the S&P 500 has breached the psychologically important 200-day moving average, and more concerns about a Chinese market meltdown - sell-offs are part and parcel of eventual market gains, although they don't always feel that way.
And running for cover may feel good in the short term, but doing so is totally counterproductive to building "total wealth."
Instead of bailing, I recommend hunkering down and using trailing stops. They're one of the most powerful weapons in any investor's arsenal.
They work a little like price targets in reverse.
They're typically calculated as a percentage of the purchase price. For instance, a 25% trailing stop on Apple Inc. (Nasdaq: AAPL), based on a purchase price of $109, is $81.75. So if the stock dropped to $81.75, the order would execute and you'd be carried out of the trade automatically.
But what makes these so powerful is that the exit price increases in lock step as the current value of your investment rises. So if AAPL shares rose to $130, your stop would move up to $97.50, capturing that much more in gains while still limiting your risk to just 25% of your invested capital.
Trailing stops lock in gains and keep losses manageable, but also they offer the added benefit of an unemotional, unbiased exit path when any stock or other investment begins to move against you. Of course, that's also the catch: You have to give up at least some ground before you're stopped out.
That doesn't really bother me because I have a long-term investor's mentality - and I encourage everyone to develop that trait. The daily volatility associated with this kind of gamesmanship is just noise, and hitting the occasional stop is just part of the game.
And, thanks in part to our trailing stop discipline, we have something other investors don't have - the luxury of calmly, coolly evaluating what's happening while deliberating our next steps.
Michael A. Robinson, Defense & Tech Specialist
The extreme volatility we've seen on the tech-heavy Nasdaq Composite isn't easy to watch, for anyone, but the last thing anyone should be doing right now is giving in to emotion, joining the panicked herd, and dumping perfectly strong stocks with huge upside.
There are a couple of easy steps to take to protect yourself while getting into position for the inevitable rally back to the top.
First, look hard at lowering your exposure. This doesn't have to be complicated. Simply halve the money you'd normally invest and keep the rest as "dry powder," so you'll have cold, hard cash on hand when the market sorts itself out - as it always does.
This next move is easy to make, too. I call it the "Cowboy Split." It entails buying a portion of your target stock at the market price and then putting in a lower limit order for the rest of the position you'd like to buy.
Suppose you wanted to buy "dog." It's off, along with nearly every other share on the market now, by 20% and going for $100.
So you buy half your position at $100, then enter a "lowball" order for $80...
That way, you catch any rally that occurs on that first tranche, and you set yourself up to pick up even more on any sizeable decline. You end up with an average purchase price of $90 a share.
So when the stock hits its previous high of $120 (and if it's tech, you can be sure it will), you've increased your profits by a bigger margin, a total return of 33% versus the 20% you would have made by taking a full position at $100 a share.
That's protection and profit in one fell swoop.
Shah Gilani, Capital Wave Strategist
Besides, the plunge just underscores my long-held mantra: "There's always a place to make money... always."
I'm looking for an oversold bounce at some point in the near future, but if we get one on thin volume, it'll be a chance to load up for the next downdraft.
What the markets need now is a good, long flushing-out to squeeze out excess built into artificially inflated asset prices.
Put options are a relatively expensive way to protect against another lurch downward, but you can pick up a variety of inverse ETFs that will return the inverse of the major indexes.
Most retail investors look to the Dow Jones, that headline-grabbing 30-stock blue-chip index. You can buy shares of the Dow ProShares Short Dow30 (NYSE Arca: DOG) to cash in when the Dow sinks.
Institutional investors, however, looking at one of the broadest possible baskets of stocks, will track the S&P 500, and the ETF that returns the inverse of that is the ProShares Short S&P 500 (NYSE Arca: SH).
It's reasonable to expect widespread, sustained downward pressure across the broad markets, so it's important to look at shorting the Nasdaq Composite with ProShares Short QQQ ETF (NYSE Arca:PSQ). And you can protect against sell-offs on the small-cap Russell 2000 by buying shares of the ProShares Short Russell2000 (NYSE Arca: RWM).
When you get those investments in place, protection is easy - and making money on the sell-offs is even easier.