Are you tired of watching your share values declining, with no control over the outcome? Sure, this is the risk you take by investing in stocks, however, just ‘holding’ stock while prices are falling is probably the riskiest approach you can take.
The wise investor knows that there are actions you can take that will help offset the loss of a falling stock price, but at the same time, you also have the potential of profiting even though stocks are falling.
The fear of making a loss is the one key factor that defines why someone will not invest in shares, or why a trade is held longer than it should be. The old phrase “It’s a long-term investment” or “It will come back”, defines the automatic response of an investor who is avoiding reality – that the stock price is falling and action should be taken.
But merely selling your stock and realizing a capital loss is not the only choice you have to take!
Following are my top 3 actions to take in managing positions that are moving against me. A good advisor will be able to provide you with information about these strategies, and implement them should you desire. If they can’t, then I’d be looking for a new advisor!
Insure your stock against a falling price
A Put option contract is “the Right to Sell your shares at a set price, on or before a set date”. Just like insurance for your car, you pay a premium to buy a Put option contract, and hopefully you won’t have to make a claim.
Put options aren’t as necessary during a Bullish stock market, or Expanding economy. But when there are negative headlines spooking investors to ‘panic sell’, implementing a Put option contract on your stock position gives you the right to sell your shares at a small cost.
Buy Free Insurance!
If the idea of buying a Put option is attractive, then you will love this one. What if I could show you how to buy insurance, but to cover the cost of the premium so there is no, or very little, cost to you?
The Collar strategy involves two transactions over your stock position. Firstly, we purchase the Put option contract which gives us the right to Sell our shares. Secondly, we Sell a Call option contract, receiving premium, which will cover the cost (or most thereof) of our Put option.
Two things you need to know about the Collar strategy: 1) Your upside potential is limited due to Selling the Call option (you are obliged to sell your shares if the share price rallies above the sold strike price). Hence, you need to be confident the share price will remain stagnant or fall. 2) You don’t necessarily have to Sell your shares if the price falls. Both the bought put option and sold call option can produce you a profit if the share price falls. This can offset the loss in the stock price, providing you with cash which you can use to buy more shares (obviously at a lower price) or to hold as cash!
Short the market as a whole
If you have too many positions to warrant buying Put options over each stock, then an alternative is to buy Put options on a leading index. For the Australian market you can purchase Put options on XJO (the ASX200 index), while for the US markets you can purchase Put options on SPY (S&P500 index).
You can easily calculate how many options to purchase as a hedge for your portfolio, or ask your advisor to calculate it for you. There will be less transaction fees but you can also ride the broader stock market movement rather than attempting to select protection for numerous individual positions.
When in doubt … Get out!
As a final note, sometimes you are best to simply take the hit and get out of the trade. We don’t know what the markets will do in the future, and if there is panic selling in the stock, there is a high probability that the share price will continue to fall.
The simplest approach is to just sell the stock and re-enter when you perceive the share price has consolidated at a fair value and is starting to show renewed buyer optimism.
My best experience here is in 2007 when I had identified a greater probability of the markets falling than recovering. I even advised my mother to sell stock and revert her superannuation into cash (which she did a few months later). We weren’t to know that the markets would produce their 2nd largest crash almost 12-months later in 2008 at the height of the Global Financial Crisis (GFC).
But this approach certainly provided confirmation that taking any action is better than taking none, as it can take many years for a stock to recover after it has fallen heavily. Knowing what strategy to implement and when is what professionals are paid to do. So if you are concerned about your hard earned investment capital, then I recommend contacting your advisor to discuss any of the above strategies.