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By Ian Wyatt


TheStreet) -- The first cracks in the market's armor appeared yesterday as investors shunned stocks and sent the indices plummeting.

By the end of the day the S&P 500 was down 1% to close at 1281 and the Russell Small-Cap index was down 2.2% to close at 787.

On the surface a 2 plus percent drop in the small caps seems like a lot -- but it's really not. To put things in perspective, the Russell advanced from 600 in September to 800 in mid-January, a 30 plus percent increase, without much resistance.

The five-year chart below shows that the index would need to fall closer to 750 before a major support level would be in danger of breaking. That level is 4.7% below yesterday's close.

At the open today, it looked as though we might be headed straight down to 750 -- the Russell immediately dropped to 776, but has since bounced back.

The relevant questions now are: where will stocks go next, should you take this opportunity to buy, or should you sell out of some positions?

The first is impossible to answer without multiple caveats. My outlook is that individual stocks will decouple from the major indices and will start to move on more stock and industry specific news. I believe that the broad market will become increasingly volatile as this decoupling happens, and that index investors will not see much difference in the value of their holdings.

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In short, I believe it's time to rebalance your portfolio. Doing so should help protect you from the downside, lock in some gains, and better position you for future gains.

My outlook necessarily means that it's increasingly important to monitor individual positions.

The time to act will be soon, but not before having a plan. We need to see the bears overpower the bulls before heading for the hills. If the bears win in the short-term, then it is likely that nearly all stocks will shed some of their recent gains, and it will be good to lighten up on the positions that you have less conviction in owning.

How much you are up, or down, on any particular position -- and your conviction in the position -- should determine whether you sell some, or all, of your shares on what you don't consider "core" portfolio holdings.

My advice would be to sell those positions that are becoming increasingly volatile, and that you don't have much confidence in. These are the positions that you wouldn't want to buy even if they were 10 or 20% lower.

Conversely, I would recommend holding onto shares in companies that you really like, and have conviction in holding through some volatility. Perhaps you'll want to sell some shares to lock in recent gains, and try to pick them back up at a lower price. Or you can use the cash you've raised through selling your non-conviction positions and average down as those stocks you want appear "on sale."

Occasionally rebalancing your portfolio is a necessary evil and is something you need to do when the market is telling you it's time.

Right now, the market's increasing volatility is suggesting that you do so. I wouldn't advise you ignore it.

Wyatt Investment Research, founded in 2001 as a publisher of newsletters, offers independent investment research of financial markets, stocks, bonds, ETFs and mutual funds to about 250,000 individual investors. The company is led by founder Ian Wyatt, who serves as publisher and chief investment strategist.