Don’t get caught in a Bear Market Rally. It may sound like good news when you hear that unemployment is falling more slowly that is was earlier -but falling is still falling. There is no end in sight to increasing unemployment and consider these other factors:

• Factory utilization fell to its lowest level since recording- keeping for this data series began in 1967.
• The ISM Index of business activity dropped for the seventh straight month.
• The S&P/Case-Shiller Index of home prices fell for the 25th straight month
• An additional 600,000 families lost their homes to foreclosure.
• The number of homeowners who fell 60 days behind on their mortgage payments grew to more than 5 million.
• The number of homeowners who owe more on their mortgages than their houses are worth grew to more than 8 million.

What does this mean?  Stock markets always rally after steep declines -but they often resume their decline once that exuberance runs out of steam.  No one knows how long this rally will last or how high it will go before correcting –but it will correct and when it does it will be bloody and fast.

If you have been back in the market for the past three months then good for you. Personally I missed most of the gain. I bailed out three weeks ago and went back into cash and treasury bills. A better move would have been to stay in the market but keep tight (<5%) stop loss orders in place.

A stop loss order is an instruction to your broker that if a stock falls below a certain price it triggers an automatic sell order.  The way to use these is to keep them moving.  For example if you purchase a stock for $20 today you would instruct your broker to sell it if it drops 5% (to $19) from that price.  A few weeks go by and the stock is now selling for $22.  At that point you would want to adjust your order and raise your stop to $20.90…and so on.  I like to update my stops every Friday after the close of the market.

If you use an electronic brokerage such as Schwab or eTrade, they offer trading platforms where you can set what is called a “trailing stop loss.”  You can set your stop using a fixed dollar amount or a percentage.  For example you could set a 5% trailing stop loss.  If your stock drops 5% from the previously highest closing price, then the system would automatically sell your stock.

Be careful setting your stop losses too close. the market is volatile and many stocks can drop 2 % or 3% pretty quickly only to rebound the next day.

So be careful and keep your powder dry.  If you lost 20%, 30% or 40% or more in your retirement funds there will be plenty of chances to get those losses back.  Do it slowly and carefully. If you make 1% or 2% a month that is excellent -but most importantly don’t lose any money.

This entry was posted on Tuesday, May 12th, 2009 at 1:26 pm and is filed under Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.