Three Ways to Weather a Market Correction

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Stock Market Analysis Video

Three Ways to Weather a Market Correction

1984 by 1984

In Case You Missed It

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In this week's Stock Market Video,  Cabot Top Ten Trader  Editor Mike Cintolo talks about the possibility of the market being in a bottom-building phase. Mike suggests you turn defensive now, with only a little new buying. Featured stocks:  GNC Holdings ( GNC ), Equinix ( EQIX ), Monster Beverage ( MNST ), Sourcefire ( FIRE ), TripAdvisor ( TRIP ), SolarWinds (SWI), Buffalo Wilds Wings (BWLD)  and  Athenahealth (ATHN ). Click below to watch.

Mike screenshot

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The inevitable market correction is underway. I say "inevitable" because one of the few truths about the stock market is contained within the old axiom of "what goes up must come down." (Which was referring to gravity, but still applies here.)

The whipsaw action of earlier this week made that clear; Monday and Tuesday morning saw the market go up, while a sharp reversal Tuesday afternoon and a gap down on Wednesday morning erased those gains. This leaves the intermediate-term trend of the market squarely on the bearish side of the needle. And because of this, you're left with a single question: What do you do now?

There are a few options facing investors dealing with a downturn like this. First is to completely cash out your portfolio and wait for the market to turn around. This is perfectly all right as a method as it guarantees that you'll have the liquidity needed to jump into the market when it starts to swing higher again. This means you can watch the downswing of the correction without worrying about losing your shirt if more stocks begin hitting lower highs and lower lows.

However, one key downside of cashing out your entire portfolio is that you're not in the best position to take advantage of any potential upswing. Neither you nor I know when the correction will stop and stocks trend higher again, so completely cashing out your portfolio strikes me as a bet that there won't be any gains made in the next few months.

The second option for dealing with a market correction is to sell your weakest stocks when the market trend turns but let your strongest stocks ride. This is the strategy of Cabot Market Letter Editor Mike Cintolo, as well as that of Cabot China & Emerging Markets Report Editor Paul Goodwin. Mike and Paul both have high percentages of their portfolios in cash right now--the Market Letter portfolio is 59% in cash and the China & Emerging Markets model portfolio is 50% in cash. (It's worth noting that Mike's been trimming his portfolio since his market-timing indicators started sending warning signals on April 10 and Paul's been trimming his portfolio since the end of February.)

For growth investors like Mike and Paul, this strategy makes a lot of sense. If the market is weak, then moving to protect the gains of your portfolio is a sound idea. And holding onto your strongest stocks also allows you to take advantage of the inevitable upmove in the market whenever it decides to happen. For more details on Mike's strategy, click here now , and for more on Paul's strategy you can click here .

The third way of dealing with a market correction is to not cash out your holdings at all, and in fact to purchase even more stocks. The reasoning behind this is that as the broad market declines, undervalued stocks of good companies become available for the savvy investor.

This third approach is what Roy Ward practices in Cabot Benjamin Graham Value Letter . It's the classic buy low, sell high mentality and market conditions like today's showcase the Value Letter's strength even more than market advances. Benjamin Graham, the creator of the value-investing system Roy adapted in the 1960s, enjoyed average returns of 20% per year no matter what the condition of the broad market.

The reason for this is Graham didn't get suckered in by the hype surrounding stocks like Facebook (FB) or Groupon (GRPN) . He applied his system of security analysis to determine the underlying value of a company. If the company was at a decent discount to what Graham determined was fair value, then he purchased the stock. Once those factors didn't line up ... well then he sold it and invested in another stock instead.

Roy's system helps you take advantage of any advance in the broad market. If you're interested in Roy's picks, which have included Apple (AAPL ) at 257 (he's still holding), please click here now .

Those are only three methods of protecting your gains in a market correction. None of them are better than any of the others, and the one you choose depends more on your risk tolerance than anything else. I'll also leave you with one more thing. No matter how you deal with a market decline, the best thing you can do is stick with the system that works for you.

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1984 Here's this week's Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.

1984 by 1984

The digital font of the first number tells you this button was likely created in the early 1970s, and from that we get a clue to its meaning-that the "modern world," meaning at least the widespread use of computers and possibly the evolution of the oligarchical collectivist society as depicted in George Orwell's novel, might arise within the next decade. Happily, it didn't, and the major factors behind successful investments remain unchanged.

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In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 5/21/12 -- The Good, the Bad and the Ugly of Options Trading


On Monday, Cabot Options Trader Editor Rick Pendergraft discussed how crucial proper money management is when it comes to options trading.

Cabot Wealth Advisory 5/24/12 - Finding Strong Value Stocks During a Market Correction

On Thursday, Cabot Benjamin Graham Value Letter Editor J. Royden Ward discussed how to find undervalued stocks in the current market environment using a simple screening process. Featured stocks: CVS Caremark (CVS) and Walt Disney (DIS).

Happy Investing,

Matt Delman
Editor, Cabot Wealth Advisory



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: EQIX , FIRE , GNC , MNST , TRIP

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