Is now a good time to invest?

I get asked that question all the time. What I usually tell people is that if you don't know what you're doing, it's NEVER a good time to invest. If you know what you're doing, it's ALWAYS a great time to invest.

When the market is falling as it has since the start of 2008, most investors lose money. It's a fact. I would guess that less than 5% of investors make money when the market falls. Are you one of them?

I think one of the biggest myths in the investing world is that if you're "well -diversified" you can ride out any dips in the market. Ask anyone who was well-diversified when the last bear market hit in 2000 and they will all tell you the same thing. I lost a ton of money and I'm still trying to get it back. Diversification is a false sense of security.

When the market gets rough there are two things you simply must do if you want to survive and prosper, protect yourself and change your strategy. The first is mandatory and the second is optional.

Before you make another trade you need to protect the ones you have. Often when I'm speaking to groups of investors, I ask how many had a catastrophic loss in their account in the past year. Usually almost every hand goes up. I then ask them if they could have eliminated that one bad investment from their account how many could have done better overall by 1-3% for the year. Again, almost every hand goes up.

What does all that mean. It means that for most investors the quickest way to make another 1-3% per year for the rest of their investment lives is to eliminate from now on the worst investment they make each year. Honestly, that's a VERY easy thing to do.

There is not a high-wire act or trapeeze artist that would ever consider going out on the wire without first putting up a safety net. It's not that they expect to fall into it, they don't. But if by some freak event they fall, they are happy the net is there to catch them. That's the same way you need to be with your investments.

Put up the net every time you make a trade. It's called a stop-loss order. It won't cost you a dime to place it with your broker. They only earn a commission to FILL orders. You'll only pay a commission if you hit your stop-loss price and the order is filled. You can place those orders today as "good until cancelled" and they will stay on the books at your broker to protect you against the unexpected dip in the market.

I suggest that you use a 7-10% stop on stocks and 30-50% on long option positions. If you ever lose more than that on a stock or option trade, SHAME ON YOU! It's very easy to protect yourself with a stop order if you just place it. Get in the habit of doing it every time you place a trade. The time to place a stop is not after the stock is already moving against you. That's very difficult to do with the powerful emotions we will be feeling. Do it first when you're not expecting your stocks to fall and you'll be happy you did. Adjust your stops as the stock rises to lock in your profits.

Secondly, you need to change your strategy when the market is falling. Most investors have NEVER used a bearish strategy in their lives. They think that diversity is the only option and they're about to find out that diversity will not protect you from losing money when the market tanks.

There is only one sure way to avoid losses when the market drops - Move to Cash. Unfortunately most investors don't believe cash is a strategy. I think it is and it's one that's used far too little. Ask anyone that lost their entire portfolio in the bear market of 2000-2003 and they will all tell you they would have much rather gotten the return on a passbook saving account at the local bank. That was an option. Why didn't they take it?

Before you can apply a bearish strategy you first have to be able to recognize when the trend changes. Here's a few tips to help you stay on the right side of the market.

I like to use moving averages to help me determine which direction the market current is flowing. I use a 21 day exponential moving average to spot short-term market trends and a 100 day EMA for longer term trends. I have a simple rule that I follow - I will never buy a stock until it crosses above it's moving average. It's that simple and it works. A stock will never make a big move when it's below it's moving average. The big moves come when it's above. So don't buy stocks that are below their moving averages and you're going to avoid some real losers.

Most stocks are going to follow the trend of the overall market, so I make sure I check the major market trends first. Just add the QQQQ, SPY and DIA to your portfolio and check a chart each day along with your other holdings. These ETF's will help you spot the changing trends in the major market. When these stocks are below their moving averages, chances are most stocks that make up these indexes are also going to be below theirs.

When stocks are below their moving averages you need to be content to earn interest in your money market account and preserve your capital, or consider applying a bearish strategy. If your analysis leads you to conclude that the dip will be short and the long-term up trend will continue, you may consider hedging your postion with options. The covered call strategy is one ofthe most basic and underused strategies available to all investors. If you'd like to learn more about covered calls, I would invite you to visit my website at stockinvestor.com and check out my variety of training programs. You can also check out optionsXpress.com and learn some basics in their education area.

A covered call is only a temporary short-term solution to a falling stock. Once the stock falls farther than the income you collect from the covered call, you're losing money that you started with. The only safe solution to avoid further losses is to sell the stock and move to cash.

When the market is bearish you can also use option strategies that allow you to profit even if you don't own a stock. I like to use a bearish call spread to make money on stocks that are tanking. In this strategy you basically sell a call option that gives another investor who you will never know or meet the right to buy shares of a falling stock from you at a price that is higher than the current price of the stock. Think of this as finding the worse stock you can find and then getting a sucker to pay you for the right to buy it at a higher price. That's what you're doing. Then you hedge your bet by using some of the money they are going to pay you for that right (the premium on the call option) to buy some insurance in the form of another call option with a higher strike price than the one that you sold.

If the stock doesn't move or continues down, you keep the premium you collected as your profit. If the stock rises higher than the strike price of your call plus the premium you collect you begin to lose money. The maximum loss is the difference between the strike prices of the call you sold and and the call you bought less the premium you collected. That's the most you can lose.

You make money in two out of the three possble outcomes (down and sideways) and can even make money if you're a little bit wrong and the stock goes up, as long as it doesn't go up a lot. I like the odds of that and it's one of my favorite strategies in a bear market.

I perfer this to buying puts or shorting stock because with those strategies I will only make money if the stock drops and I will lose money if it stays the same or goes up. The attraction of those strategies is that the profits have no limit, but I'm content to take the better odds on a limited profit and limit my risk substantially as well.

Bottom line, in a market like we're had thus far in 2008, you need to first get a stop in place on every stock you own. If the stock is already below it's moving average, you're a little late, but still do it, because it could get worse. Don't be afraid to sell those losers and move to cash. You'll likely have a better chance to earn back your loss on a new investment when the market improves than waiting it out in a bad investment hoping it gets better. HOPE is NOT a strategy.

If you protect yourself and apply bearish strategies when the market trends turn south, you'll be able to survive and prosper in any market.

Happy Trading.

Ross