Seven Ways to Handle Market Stress

The next step is to identify the beta of your overall portfolio. You can do this by adding up the total betas for each position and then dividing that total by the market value of the portfolio.

A portfolio beta greater than 1 indicates that your portfolio will move at a rate greater than the overall market. For example, a portfolio beta of 1.2 means that your portfolio will move 1.2 times the market index , whether it moves up or down. We can see this as another form of leverage -- for $1 of investment, you are getting $1.2 of market moves. The higher the beta, the more risk you have. Reducing your portfolio's beta will help to alleviate risk in uncertain and volatile markets.

3. Know What to Sell

Not all market declines are the same. You need to understand what sectors or groups of stocks are under stress and are the "causal influence" on the market's decline and volatility. If you own these stocks, then they tend to be the weak link in your portfolio.

For example, right now (summer of 2007) we are in the midst of a financial-sector driven decline. So look first to the financials for sources of risk reduction. If the financials represent 20% of the S&P 500 (SPX Quote) then cut your financial stock weighting to less than 20% or even zero, if the pain is too much for you.

Down the road, when you experience another volatile market, what should you sell? There is no right answer, because in addition to no two markets being the same, no two investors are alike. However, here is a list of several professional rules of thumb:

• Sell losers rather than winners (see "Winners & Losers" ).
• Sell positions that you have "doubled down" on. (Doubling down is when you add significantly to a losing position when the stock has declined.)
• Eliminate high beta names and keep the less risky, low-beta holdings.
• Eliminate the marginal ("last in") or fringe position.
• Cut your portfolio down across all positions in a pro rata fashion, which means by a set percentage across the board.