Before we dive into specifics, please keep in mind that market corrections are a natural progression. At some point, investors take profits. When that happens, someone will lose money, whether it’s booked or assumed. No one rings a bell to say “Get out here” or “Take some profits there.” You could go from wealthy on paper to poorer in real dollars at the drop of a hat.
How to prepare for the next market correction
Another correction will come eventually, so now is the time to do two things: Hold onto a larger amount of cash and buy index put options as protection (you can read more about that in this recent blog post).
Keeping plenty of cash on hand is difficult for some traders. However, when those stock prices start falling, you’ll be ready for any fantastic trade opportunities that appear. The challenge is to time it right. When we’re in a strong bull market run, it can be really hard to get on board. A correction can be your opening.
I like to take advantage of a 3-5% market correction to add to current positions or establish new ones. I also use it as an opportunity to weed out older names that are already correcting or not enhancing my portfolio. Take General Electric, a perennial loser. I would have cut it loose and exchanged it for a better performer in the group (like Honeywell or Boeing) when these stocks pulled back years ago.
Keeping cash on hand is key to successfully trading options over the long-term. It allows you to exchange non-performers for new opportunities and jump in during a correction to scoop up stocks that are suddenly on sale. These are the moments when large wealth shifts are made – take advantage of them.