Monday was the worst day for U.S. stocks in nearly two years. Markets around the world plunged; the S&P 500 index was down 3%. The catalyst was economic data that suggested the economy could tip into a recession.

Whether these fears are overblown or not, the rout in equities begs the question: are you sufficiently prepared for corrections?

For starters, take a deep breath and remember that weakness in the overall market isn’t sufficient reason to dump inherently strong stocks. Markets rise and fall, but over the long run a well-diversified portfolio provides the best gains.

As a rule, don’t let the alarmist headlines spook you into selling. The last thing you want to do is prematurely dump your stocks out of panic. Long-term investors should not be spurred into impulsive actions by short-term declines.

Consider these five steps. They may seem basic, but even seasoned investors sometimes forget the essentials:

1. Stop losses

One of the most widely used devices for limiting the amount of loss from a dropping stock is to place a stop-loss order with your broker (see graphic).

Using this order, the trader will pre-set the value based on the maximum loss the investor is willing to tolerate.

If the price drops below this fixed value, the stop loss automatically becomes a market order and gets triggered.

As soon as the price falls below the stop level, the position is closed at the current market price, which prevents any additional losses.

The “trailing stop loss” provides an advantage over a conventional stop loss because it’s more flexible.

It allows the trader to continue protecting his capital if the price drops, but when the price increases, the trailing feature becomes active, enabling an eventual protection of profit while still reducing the risk to capital.

Over time, the trailing stop will self-calibrate, shifting from minimizing losses to protecting profits as the price reaches new highs.

2. Cash cushion

Maintain a portion of your portfolio in cash or cash equivalents to take advantage of buying opportunities during a market downturn. An allocation of at least 10% makes sense now, depending on your time to retirement and tolerance for risk.

3. Hedging strategies

Use options and futures to hedge against market declines. For example, buying put options can provide downside protection. Consider inverse exchange-traded (ETFs) that increase in value when the market declines, though they are typically used for short-term strategies.

4. Alternative investments

Increase your exposure to real assets such as real estate, precious metals (gold, silver), and commodities to provide a hedge against inflation and market volatility.

Real estate is gaining luster, as weak economic data makes it more likely that the Federal Reserve will cut interest rates in September.

In addition to benefiting from lower rates, real estate is a tangible asset that tends to retain value over time. Unlike stocks and bonds, which can fluctuate significantly in value, real estate provides a physical asset that has inherent value.

5. Defensive stocks

Invest in sectors that perform well regardless of the economic cycle, such as utilities, health care, and consumer staples. Consider ETFs that focus on low volatility stocks.

As a buffer against corrections, I particularly like utilities. This sector includes companies that provide essential services like electricity, water, and natural gas. Demand for these services remains relatively stable regardless of economic conditions.

Even during economic and financial downturns, people still need power and water, ensuring a consistent revenue stream for utility companies. This stability makes utilities less volatile and more reliable during market turbulence.

Stocks rebound on Tuesday…

To quote another song: what a difference a day makes.

Global equities came roaring back on Tuesday, as Wall Street concluded that the most likely culprit for Monday’s swoon was the unwinding of the Japanese yen carry trade. Recession fears abated.

The Japanese yen carry trade is a popular financial strategy where investors borrow yen at low interest rates and use these funds to invest in higher-yielding assets in other currencies. The fundamental idea is to exploit the interest rate differential between Japan, where interest rates have been historically low, and other countries with higher interest rates.

The Bank of Japan hiked interest rates last week from 0% to a quarter point, which wreaked havoc with the yen carry trade. Traders scrambled to cover their overextended bets.

On Monday, Japan’s Nikkei slumped 12% in its worst losses since Black Monday 1987. But on Tuesday, the Nikkei soared 10%, posting its biggest one-day rise ever in points.

The main U.S. stock market indices closed sharply higher on Tuesday, as follows:

• DJIA: +0.76%
• S&P 500: +1.04%
• NASDAQ: +1.03%
• Russell 2000: +1.23%

All “Magnificent Seven” stocks rose. Likewise, all 11 S&P 500 sectors closed higher.

The CBOE Volatility Index (VIX) plunged about 33% to hover at 25.85. The benchmark 30-year U.S. Treasury yield rose 2.58% to settle at 4.17%.

You should still implement the aforementioned safety measures for your portfolio; elevated volatility is likely to continue into the foreseeable future. Remember, too, that the tech-heavy NASDAQ remains in correction territory.

However, Tuesday’s rebound is an object lesson in why you should never make decisions based on raw fear.

WATCH THIS VIDEO: Inside “The Income Zone” With Robert Rapier

Editor’s Note: If you’re looking for ways to generate high but safe income, regardless of today’s uncertain conditions, consider the advice of my colleague Robert Rapier.

Robert Rapier is the chief investment strategist of Utility Forecaster, Income Forecaster, and Rapier’s Income Accelerator.

Robert is one of the world’s foremost experts on utilities and income investing, but his deep knowledge also extends into other profitable segments.

Want to learn more about Robert’s profitable, crash-resistant trades? Click here.

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John Persinos is the editorial director of Investing Daily.

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