Downside risk is a part of investing, whether it’s with single stocks or exchange traded funds (ETFs). There are four strategies that can help ETF investors protect their capital even when the market is not cooperating.
The strategies that can help ETF investors protect their money in a down market are also useful with single stocks, as ETFs are simply a basket of stocks. Hans Wagner for Forbes explains:
1. Know when to sell your ETF: Just like having an entry strategy is important, so is an exit straegy. Moreover, it is pertinent to know when it is time to get out and walk away. An investor should consider selling an ETF when their risk tolerance has been had.
If you can’t sleep at night, it’s time to get out. We have a plan for exiting in increments. Stop orders are a good tool for for closing out a position at a predetermined amount. This keeps your losses at bay. If you need the money for that rainy day, by all menas, use it. Rebalancing a portfolio is also a good time to get out of a troublesome investment. If you expectations have not been met by a particular ETF, don’t beat yourself up or wait any longer. There is surely an ETF out there that can.
2. Allocate your assets: Investors can further protect their assets by allocating assets into a wide array of classes, such as equity market capitalizations and sectors. These ETFs allow investors to construct portfolios that are consistent with their tolerance for risk and their goals.
3. Sector Rotation: By following the rotoation of industry sectors based on economic cycles, ETF can help investors protect and adapt accoding to current affairs. The business cycle is the pattern of changes with the GDP and include expansion, prosperity, contraction and recession. Investors who follow this strategy adjust their portfolio’s sector weight to align with the sectors that are most likely to perform best.
We prefer to use a trend-following strategy, using the 200-day moving average as a guide for when to be in and out of the markets.
4. Use a hedge: Hedges are particularly useful if an investor is facing a down market. To be effective, hedges need not make money, they must only limit risk. An expected future event or trend can be met head on if an investor uses a hedge and thus limit downside risk.
If another downturn hits, it is important to have an exit strategy in a down market. Our strategy notes that it’s time to get out if an ETF falls 8% off its high or falls below the 200 day-moving-average. This way losses are kept to a minimum.
You can watch for signs to get back into the market by keeping tabs on market trends and watching the 50-day moving average. There are other market indicators to watch for; some signs the market may have stabilized include the inventory of unsold homes falling, houses selling more quickly than they have in recent years, and prices starting to go up.