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Other than the obvious answer of going to 100% cash, here are a few suggestions for reducing risk exposure in your portfolio during a volatile or corrective market environment:

1. Get off margin immediately
2. Raise at least 25-50% cash
3. If you choose to trade, take smaller than normal position sizes
4. Reduce overexposure in any one industry group and diversify more broadly
5. Reduce exposure to high beta stocks
6. Avoid laggard stocks (even if they look cheap)
7. Nail down profits when you have them (be less greedy)
8. Tighten up your stop-losses (be less forgiving)
9. Sell all stocks that break down in price (especially if they cant rally)
10. Upgrade in quality and reduce exposure to low priced stocks

-Mark Minervini

Mark Minervini
January 21, 2011 @ 12:15AM/EST

Wednesdays market action contained enough set-up failures to move the leading stock portion of our risk model to a current reading of negative from neutral. An even more obvious clue of faltering leadership was F5 Networks price response to earnings announced after Wednesdays close; the stock traded down more than 20% in afterhours trading. The weakness in FFIV caused a spillover of selling in other leading names, specifically cloud computing and related stocks such as VMW, CRM, ARUN, AKAM, APKT, RDWR, RVBD, JNPR and NTAP; they were all down in extended trading.

Like many names that have led this market, F5 Networks had formed a number of price consolidations along the way during its price advance; the most recent was clearly late stage. As we have pointed out in recent weeks, many leading stocks have emerged from late stage bases. Although our risk model has not yet flashed a sell signal, its important to keep a close watch on leading stocks and the stocks in your own portfolio. Market and sector weakness will generally show up in individual names first.

We continue to see more and more evidence that the start of a market correction may be underway or near. At the very least, we see it becoming increasing more difficult to make money in the market over the near-term.

To reiterate our recent advice: take smaller than normal positions, tighten stops, and nail down profits when you have them. Most importantly, religiously cut your losses on the names that move against you in order to protect yourself.

Mark Minervini

As Ive discussed in recent market commentary, we see signs of a rotation into larger cap names and also into some of the laggard stocks. This is a clear indication of late stage market action. While we dont see an end of the bull market on the horizon over the near term, a 4-8% correction (give or take a few percent) is likely looming. We have recently added some short positions to the portfolio to partially offset risk from our long exposure. Additionally, we have shifted to a tighter than normal loss cutting policy, giving stocks in our portfolio little room to move against us.

The market may indeed keep crawling its way higher however, if the rally contains less and less participation, it will become increasing more difficult to make money. Therefore, our recommendation is to take smaller than normal positions, tighten stops, and nail down profits when you have them.

Mark Minervini

The engine behind this bull market are low interest rates driven by economic weakness. Bull markets are born out of recessions and this one is no different than many past bulls.

Despite recent relative strength in home building stocks, the housing market is still depressed as there remains an oversupply of homes as well as an abundant supply of foreclosures. Commodity prices are on the rise again however, core inflation and wage inflation remain weak. The employment picture has not yet improved enough to allow the Fed to normalize rates. Therefore, the proverbial punchbowl remains on the table with additional re-fills likely.

Bottom line: There is little competition for stocks.

The Feds commitment to stimulus is likely to persist throughout 2011. The extension of the Bush tax cuts and the 2% cut in the employee payroll tax rate and a 2-year extension of depreciation incentives for business investment is also a form of stimulus. The above coincides with a favorable election cycle period and a market that is trading at a reasonable multiple when the current interest rate environement in considered.

Certainly, the fundamental tailwinds remain strong. More importantly, our longs continue to work and the market refuses to give up much ground. Therefore, we continue to stick with our plan and add new names as they emerge on a stock-by-stock basis.

The big question is: how far out is the market looking forward and when will it cease discounting the positive side of the coin? The answer: no one knows. This is why regardless of how great all the rhetoric sounds, we adhere to strategy.

To put it in simple terms, all the statistics, analysts opinions and pundit predictions on Wall Street wont change the fact that we sell our stocks when they stop us out and we stop buying stocks when they cease to set-up constructively. In my 30 years as a stock trader, I have learned that this is by far more important than opinions and forcasts, including mine.

Until then, we continue to trade the best SEPA situations as we remain on a buy signal, and the party continues.

Mark Minervini

He believes that investors will be waiting a very long time for a traditional bull market. He recommends being a value investor and not being afraid of keeping some investment funds in cash. In order to protect yourself on the downside, he recommends buying stocks that are cheap, based on discounted cash flow. Chapter 12 is important as he covers an often overlooked subject, when to sell. Most important, he covers how to find new stock ideas.

If you are looking for a concise easy read on investing in sideways markets, get The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere.

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If our caution proves to be warranted and the market does correct over the coming days and weeks ahead, our work suggests the pullback will be relatively small and contained within the 4-7% range (give or take a percentage or two) on the major averages. The broader indexes such as the Russell 2000 will most likely be hit the hardest, as we have pointed out the recent relative outperformance in many of the bigger cap names.

Over the past two weeks we have sold and paired back many of our portfolio holdings. Over the short-term, we feel most stocks need to correct, or at the very least, consolidate. This does NOT however, mean that we will completely abstain from adding new longs to the portfolio on a select basis.

There is always the possibility that the market turns up and moves right back into new high ground even without broad participation. It is precisely for that reason we stick with our investment theme until proven wrong and let the market itself guide us as opposed to rigidly clinging to personal opinions or theories.

If the overall market is going to get into serious trouble, our stop-loss protection will force us to the sidelines one stock at a time. Currently, our risk model remains on a buy however; it is teetering on an intermediate-term sell. Short-term caution is our stance de jour.

-Mark Minervini

We note recent relative strength in some of the larger cap, relatively low RS stocks such as IBM, PCS, QCOM, F, CSX, VZ, DIS, etc. as evidence of rotation. While we currently own some of these larger cap names in an attempt to profit from the rotational nature of the market, we would prefer to see the original market leaders continue to lead, which to us, would be a better indication of overall market heath.

For the above stated reasons we are downgrading the Leading Stock portion of our risk model to neutral from positive. This does NOT yet put us on an outright sell signal or indicate that I think we’re starting a bear market; but rather, its a heads up as we point out rotation and the increased possibility of a market pullback. It certainly heightens our awareness to be on the lookout for additional signs of internal fragmenting among leading names and even more obvious signs of distribution in the major averages.

Of course, the market has moved up quite a bit and most market participants seem to be pretty bullish these days. A pullback in the market would be normal however, we treat every market pullback and signs of weakness as potentially threatening and always entertain the fact that every 10-15% decline starts as a 2-3% pullback, just as every 25-30% bear market begins as only a 10% decline. One never knows for sure how far the market will drop or rally. This is why we have stop losses and why we adhere to strategy.

If we should get additional strength in the market going forward in the coming days and weeks ahead, it makes sense to take that opportunity to nail down some profits in those stocks that are extended in price. Conversely, as always, cut your losses on those situations that move against you.

Mark Minervini