When the road gets rough, most folks tighten their grip on the wheel.
But how exactly do you do that with stocks
The most common strategy for growth investors in a correcting market is to move to cash. But there are sometimes signals that a correction may be short-lived. Or, investors may own a stock that appears set to advance despite the overall market conditions.
These are just two of many reasons that may urge growth investors to decide not to take profits and rotate entirely to cash. Under these and other circumstances, two of your most effective offensive precautions include scaling down your price target and narrowing your loss allowance to less than 5%.
In the healthy market, your nominal price target on stocks might be 20%. IBD founder William O'Neil, in his book "The Successful Investor," recommends "selling a few of your stocks when they are up 20% to 25% from your purchase price.
Investors using the price-to-earnings expansion method may chart sell points well beyond 20%.
But correcting markets are stingy and unpredictable. Gains of 10% or more can be tough to muster. And a 10% gain can turn into a quick loss in the first few seconds of a panicked trading session.
It happens to even the most fundamentally sound stocks.
To defend against such volatility, narrow your top-end target to 10% to 15%. Consider taking profit even earlier — at 3% to 5%, for example. Remember, pulling off a pair of 5% to 10% wins in a correcting market leaves you well above where you would have been if you'd rotated entirely to cash. And it puts you far above those who watched their holdings correct along with the market.
Impax Laboratories (IPXL) broke out of a first-stage, base-on-base pattern 1 just as the market was starting to correct in September. It rose 9% through Oct. 2, then pulled back and dropped below support at the 10-week moving average. It collapsed Oct. 31 in massive trade. A downsized sell target could have captured the bulk of that advance.
On the downside, don't wait for the normal 7% to 8% loss to exit a stock. Dips, especially in heavy and those that break support at their 50-day or 10-week moving averages, tend to rapidly worsen in correcting markets.
Tighten your baseline loss allowance. If you use trading stops, set them to a 3% to 5% maximum. For investors with a high risk tolerance, this can be a tough sacrifice. It means being shaken out of some stocks that dip 5% or 7%, then turn and run higher.