This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Cramer's Action Alerts PLUS - See his portfolio and get alerts BEFORE every trade. Learn more NOW!

5 ways to limit risk from stocks





Do you feel trapped in the stock market? It's a natural feeling, given today's conditions. The stock market is soaring to nosebleed heights, but as rational as it may seem to scale back, the lack of attractive alternatives has investors tightening their grips and preparing to hold on for the ride.

However, if you don't want to passively stay on board until the next crash, there are some things you can do short of a complete pullback from the market.

Too far, too fast?

A soaring stock market is a nice problem to have, but it is a problem.

Forget the news stories about how the market keeps reaching all-time highs. The absolute price level of the stock market -- or any individual stock -- does not matter as much as valuations. The good news is that earnings are rising. The bad news is that prices are running well ahead of earnings.

This year is on track to represent the second year in a row in which stock prices have risen faster than earnings. As a result, the price-to-earnings ratio of the S&P 500 has risen by more than 30 percent. Perhaps more alarmingly, the price-to-earnings ratio for operating earnings -- the meat and potatoes of a company's business -- has risen by more than 34 percent.

Barring an extraordinary boom in earnings, which does not seem consistent with a sluggish global economy, there are two choices for bringing prices back into alignment with earnings. Either prices can fall, or prices can wait for earnings to catch up. This leaves investors with a choice between a falling market and dead money, so alternatives, as unattractive as they may be, must be considered.

Five possibilities

If you feel trapped in the market despite concern about risk, here are five steps to consider:

  1. Reallocate new contributions. If you can't bring yourself to sell stocks, at least direct new retirement plan contributions to more conservative investments, to gradually water down your exposure.
  2. Shift to more defensive stocks. You can keep your stock position where it is, but perhaps slide some money from high fliers into more plodding-but-sturdy sectors of the market.
  3. Take a microscope to your portfolio. Never mind big-picture generalizations about the market and valuations -- how do the individual stocks in your portfolio look when you examine them close up? Now would be a good time to consider whether you have diminished expectations for any of their business models going forward, or if some valuations have made too great a leap from reality.
  4. Decide when to sell, if not now. With respect to either individual stocks or the level of the market as a whole, if you can't bear to sell now, then set targets for when you would be willing to sell. Setting those targets in advance will make it easier to follow through when the time comes.
  5. Remember that a small positive beats a negative. Saving account rates of less than 1 percent and certificate of deposit rates in the 1 to 2 percent range may not seem like great alternatives, but those positive numbers would look pretty good compared to a 10 or 20 percent decline in stocks.

Market psychology is a powerful thing, but it is just psychology. You are not really as trapped in the market as you might feel.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Try it NOW
Only $9.95
Try it NOW
14-Days Free
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
SYM TRADE IT LAST %CHG

Markets

DOW 17,776.12 -200.19 -1.11%
S&P 500 2,067.89 -18.35 -0.88%
NASDAQ 4,900.8850 -46.5560 -0.94%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs