Investing with Carol Perry: Spot signs before stock market corrections

Ouch. The stock market has really been getting hammered recently. For some of you, that sense of fear in the pit of your stomach is back. For others, you are starting to get a handle on how to see a correction looming. Let's take a look at some of the factors or red flags recently that indicated that the market was overbought or overvalued. The better you get at recognizing the signals, the better trader you will become.

With the S & P up 80 percent since March 2009 and a recent and dramatic rally to the upside, there were other signs that the market was ready to correct or pullback. For starters, the number of stocks in the S & P 500 that have a standard deviation of one above the 50 day moving average has steadily risen since the recent rally began. This is a good indicator that the market is overbought.

Another indicator is that the average mutual fund cash position is near it's historic low of about 3.6 percent. Meanwhile, the price earning ratio of the S & P 500 was 22, well above the mean of 16.

When you see these numbers, you know there is smoke somewhere. All it takes to set off selling programs is for something to go wrong. This time around, it was the debt crisis in Greece that spilled over into all markets.

Now you are probably thinking that you have been hearing about Greece's problems for months, so why now? We did not have the above mentioned indicators in the S & P until recently.

Now let's talk about how low things can go. If the market is down 10 percent, that is called a correction, if down 20 percent, we are in a bear market again. As of this writing Thursday, we had crossed into correction territory.

This pullback feels nothing like the one in September 2008. Back then, the markets were in total freefall. This correction seems more like a normal situation when people or institutions have seen the value of their positions rise and are now taking profits. Corrections are actually a good thing periodically, even though it does not feel like it at the time. Without corrections, we get bubbles and we all know now that bubbles burst. Then things get real ugly.

Now after the last correction and bear market in 2008, what did you do? Did you have an advisor that called you and gave you advice on how to reposition your assets to best protect your principal or your potential for growth in the future? If you did and they did, then this correction should not be too painful. Each time we have a correction, it is an opportunity to learn what to do in the future and more importantly, what not to do.

Now if you had an advisor that did nothing and said hang on you will be fine, I would think about that relationship. Especially if you were retired and preservation of principal was your primary objective. If you hung on to stock mutual funds or ETF's back in 2008 through March 2009, you most likely lost a lot of money.

My opinion is that the growth we saw in the late 1990s and 2000s was based on a bubble in the real estate markets and we will not see that again for some time, if ever. If you were doing your own investing, hopefully you were using the tools and advise provided by the company that held your assets. I have found Fidelity, Vanguard and Schwab to be well equipped to handle your trading and questions. I am sure there are other firms, I just cannot give you an opinion having no experience with them.

Times have changed folks and if you are using the same old pre-2008 strategies, you may be in trouble. Retirees should be keeping much larger cash positions now, and rebalancing your portfolio more frequently can keep you from getting overweighted in equities that have run up and are ripe for profit taking. Also keep in mind using stop loss or limit orders to keep losses at a minimum. Today's high-frequency trading can cause huge drops in very short time periods as we saw in the recent one day "flash crash." High-frequency trading or algorithmic trading (aka black box trading and robo trading) is a whole article itself, but let's just say as an order management system, it may have a few bugs to work out.

Protect yourself and be an informed investor. I know I have said it before, but I will keep on saying it until people start taking the initiative to understand their investments and the hazards they face in today's rapidly changing market environment.

• Carol Perry has been a Northern Nevada resident since 1983. You can reach her at carol_perry@worldnet.att.net.