Strategies for an Overextended Market

This market is just downright crazy. It seems like no matter what happens in the economy, with earnings, on the political front or on the world stage, stocks still act like the Energizer Bunny — they keep going, and going, and going and going.

To give you a sense of just how far stocks are extended in relation to their long-term, 200-day moving averages, let’s take a quick look at the following charts.

First, we have the S&P 500 Index, which is now 19.5% above its 200-day moving average.

Next, we have the tech-heavy NASDAQ 100 Index, which is 26% above its 200-day moving average.

But this overextended market isn’t content to stay within U.S. borders. Take a look at the chart below of the iShares FTSE/Xinhua China 25 (FXI), an ETF representing the biggest Chinese stocks. Here we see FXI is 31% above its 200-day moving average.

Of course, it’s not just the red-hot emerging market dragon that’s seen big gains. The EAFE Index (EFA), which represents the equity markets in Europe, Australasia and the Far East, also is overextended. The EAFE now is 27% above its 200-day moving average.

So, how do you manage your portfolio in this overextended market? Well, if you have gains, make sure you keep them. That means you have to make sure you have stop losses in place on all of your positions. The last thing you want to do is give back a significant percentage of the ground you’ve made up over the past several blazing-hot months in the market.

If you are looking to put new money to work, then you can do so, but make sure you proceed with extreme caution. The worst thing you can do is buy at the top and watch your money float down the drain. If you are going to invest here, make sure you define your risk by putting tight stop-loss orders on any new positions. Also, make sure you don’t throw all of your money into stocks at once.

If you are going to put some new money to work, make sure you do so incrementally. If this rally continues, you can keep putting your chips in the pot in a judicious manner.