The Risks Of Selling The Rally

stock rallyDavid Fabian:  Investors that were fortunate to buy into the hole in either August or September have now been rewarded with a double digit gain on most broad-based indices. 

What began with some skepticism as just a short-covering binge has now morphed into the notion of a full blown recovery.

There is even quite a bit of debate on whether or not we could take out the prior all-time highs on the S&P 500 Index before the year is out.

Of course, if you had the tenacity or good luck to buy the dip, you may question the risks of overstaying your welcome on the upside.

Those that took a more active approach in loading up on stocks near the lows are likely just as leery of a blow off top that ends in a swift and pernicious drop.

Below are some bullet points that may provide a road map to making this difficult decision a little easier to digest.

1.  Evaluate your time horizon and investment goals. If you are short-term trader with defined risk parameters, then taking off some of your long positions into this run higher may be a prudent decision.  It will free up cash to evaluate other opportunities and offer the flexibility to deploy capital when needed.  Conversely, long-term investors may not be as concerned with these daily machinations and are willing to ride out additional volatility in order to stick with their plan.  Here is a short guide to some of the key differences between being an investor and a trader.

2. Consider making changes in small increments. If you took an above-average risk by loading up on stocks at the lows, then you have more flexibility to bank profits on the way higher. That may include breaking trades up into two or three pieces in order to slowly reduce your stock allocation over time.  That way you can still participate in additional upside momentum if the market continues on the current course, but don’t have as much to lose if it turns lower.

3.  Don’t count on timing the market perfectly. There was a risk of buying on the way down that the market continues falling even further and compounds your losses.  Similarly, there is an even greater risk that selling on the way up will leave you underinvested as the market continues to march higher.  No one knows exactly where and when inflection points will form.  Hanging on to some token long exposure may allow you to avoid the FOMO (fear of missing out) syndrome that leads to poor decision making at inopportune times.

4. Analyze the risk profile of your exposure. If you loaded up on high beta sectors of the market such as technology or consumer discretionary stocks, it may be prudent to switch to a more defensive approach.  That could include a low volatility index such as the PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV) or individual sectors exhibiting less relative price sensitivity.  That way you are still able to participate in some measure of upside potential with the intent of reducing downside risk.

 The Bottom Line

There is always an opportunity cost when you make a change to your portfolio that your intended actions lead to more harm than good.

Nevertheless, with a well-thought out game plan and sound portfolio management principles, you can enhance the odds of a favorable outcome.

This article is brought to you courtesy of David Fabian.

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