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Get ready to profit from an autumnal pullback in indices

OPTIMISM has been returning to the markets recently, but it would be foolhardy to believe that the worst is over. Last week, David Buik at BGC Partners pointed out that after the initial crash in 1929, the markets staged a powerful rally that retraced 60 per cent of these losses. Since the 6 March 2009 lows, he pointed out, the S&amp;P index has also retraced a significant portion of its losses &ndash; rallying over 50 per cent in the past five months. &ldquo;Right now, we&rsquo;re exactly on pace with 1930,&rdquo; says Buik. &ldquo;While we can&rsquo;t be sure that history will repeat itself, it&rsquo;s too early to rule out this possibility as well. Proceed with caution.&rdquo;<br /><br />While stocks have indeed experienced a meteoric rise, the same is not true of other assets. David Rosenberg, market strategist at asset manager Gluskin Sheff, points out that if we were in the midst of a reflationary or a major asset allocation shift, the US Treasury market would be selling off. Instead, the yield on the US 10-year Treasury note is some 50 basis points below its recent highs. Also, the Baltic Dry Index &ndash; a measure of shipping activity &ndash; slid 10 per cent last week and is down 26 per cent in August to reach a three-month low.<br /><br />So what should spread betters do to protect their portfolios against an autumnal market dip? First, those already long of the major indices and sectors like banking and mining which have been leading the recovery should look to lock in at least some of their profits while they still can, perhaps by implementing a trailing stop loss on their position, which will always remain a set percentage below the index price. If you are still sitting on the sidelines, then you may want to buy on the dips in the very near-term and scalp a few points profit here and there, but anything more forward-looking is risky at the moment, when there are growing calls from brokers for investors to take profits &ndash; JP Morgan last week downgraded the mining sector to neutral from overweight. Those who are not long now should not enter long index positions with the intention of rolling them over into the next trading session.<br /><br /><strong>MAJOR INDICES</strong><br />Secondly, look to the major indices rather than individual stocks. Indices have the tightest spreads but the greatest liquidity. If you enter a short-term spread bet on an index you should have no difficulty exiting your trade whereas, given the low volumes that we are still seeing, this might not be the case for individual stocks. Being able to reverse your trade when you start to see bearish signals appear in both the news and the charts is important for your survival.<br /><br />Finally, what if indices aren&rsquo;t a common trade for you? One method of protecting your portfolio from an autumn slump is to switch into defensive sector CFDs. Brokers have already been encouraging investors to switch into defensive stocks and away from the cyclicals. Choose sectors such as utilities that have a low beta (less than one) as this measures the tendency of a security&rsquo;s returns to respond to swings in the market. If you add these to your portfolio then you will protect yourself more against sharp swings in the market and are less likely to see your position wiped out in the space of minutes. The alternative is to pick stocks that still have further to rise.<br /><br />Simon Denham, managing director at Capital Spreads, says that some sectors are looking a bit overbought and so you have to look harder for the stocks that are still likely to have steam left in them. For example, banks RBS and Lloyds, both of which have been almost treading water compared to the likes of Barclays. Since the lows of March, Barclays has rallied some 480 per cent, whereas RBS&rsquo;s gain is a mere 194 per cent and Lloyds&rsquo; 260 per cent. Such stocks should also protect you: in any equities slump, those which have participated less in the rally will have less far to fall. If that sounds negative, well, this autumn, optimism is going to be out of fashion.