When Active Investors Should Add Or Reduce Risk

The terms for bull and bear markets are often bandied about with reckless determination. It’s generally accepted that a gain of 20% or more is considered a bull market. Conversely, a drop of 20% or more is bear territory.

Based on the most recent intra-day high of 2,177.09 on the S&P 500 Index, a full-blown bear market wouldn’t be recognized until 1,741 was breached. That’s much farther than most people realize. In fact, it would wipe out the last three years of gains in large cap stocks and undercut both the 2015 and 2016 lows.

Of course, many investors would be calling the end of the world way before that. We saw these determined proclamations near the 2016 lows. Most just assumed we were headed for a bear market and were told to invest accordingly. Now, we are back to fresh all-time highs, and I would wager that many are still waiting on the sidelines with a good portion of cash.

I bring this up because, in my opinion, too many investors are behaviorally influenced by categorizing the market as bull or bear. They succumb to the urge to sell everything after a big dive, when fear is most prevalent. Truthfully, the exact opposite mindset should be promoted.

Active investors should reduce risk as a function of strengthening markets and add risk as a function of weakening markets. 

Some traders are disciplined enough to buy individual stocks that are breaking out to new highs or demonstrating high momentum characteristics. However, their strategy generally includes short-term holding periods and disciplined risk management plans. It doesn’t play to the strengths of those who believe in a longer-term mindset and a general low or moderate level of account activity.

It’s easy to hold positions when they are continually trending higher during a period of relatively low volatility. It ushers in a sense of complacency and pleasure. Almost like sitting in a Jacuzzi for a long period of time. The harder part is knowing when to reduce risk as conditions become frothy, targets are hit or new opportunities show more attractive risk/reward characteristics.

Worrying less about labeling the current market environment and more about the factors that are in your control can meaningfully contribute to your bottom line.

If you want to learn more about the five qualities that will make or break your portfolio,click here.