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The key to weathering a market downswing is intelligent risk management. Successful traders make money even if they're wrong in their predictions. To achieve this goal, they sacrifice some of the potential profit that will result from any given situation.

Market neutral trading is a good way to make a living, but is nothing like the rags-to-riches fantasy of watching a portfolio filled with sorry little tech stocks suddenly skyrocket when the bears decide to hibernate. It's slow going, and gains will be moderate. Even a savvy market neutral trader starting out with a modest capital investment may not make more than, say, the average engineer. Engineers, however, have to spend the day with a boss and their coworkers, while I spend the day with my Lab. So I can't complain.

I rely on a defined, specific options strategy when trading, but there are a lot of ways to build a portfolio that will withstand market changes. These are a few time-tested ways to ensure against downswings.

1. Look for companies that succeed in any market.

If you must hold long stocks, have a variety of sectors. Pharmaceuticals, tobacco, and food companies tend to resist market down trends since the demand for their products is relatively inelastic. Some stocks, like McDonalds and WalMart tend to perform better in bear markets since people buy their products when low on money.

2. Hold stock in long ETFs.

An ETF is an exchange traded fund. Buying an ETF stock means investing in predefined, weighted portfolio based on several different stocks. ETFs are buffered against drastic change since no one company's success or failure can make a catastrophic difference.

Long ETFs like the Nasdaq index (symbol QQQQ) still decline in value when the market takes a dive, but not to the extent that an individual stock may.

3. Hold stock in short ETFs.

An ETF like Nasdaq short shares is a portfolio of short stock, and will increase in value when the stocks in it decrease in value. As an ETF, such a stock will be buffered against drastic changes. In a bear market, this position will increase in value and offset the losses on long stock positions.

Note: if you have both short and long stock positions, it is likely that only one will increase in value, while the other decreases. Hence, market neutrality will cap your profits, sometimes severely. It will also hedge against potential losses. The key is optimizing your positions to balance potential for profit with protection against loss.

4. Sell calls on all long stock.
Make sure the strike price of the call is higher than the price you paid for the stock (or at the very least, make sure the strike is at a price for which you are willing to sell the stock). If the stock goes up, you may have the call assigned and end up selling it at the strike price. That's why your potential gain on that stock will be capped.

The good news is that if the stock goes down or just stays below the strike price of the call, you walk away with the call premium. When the call expires worthless, you can sell another one. You may not be earning dividends or seeing your stock increase in value, but you'll be generating a nice little cash stream.

Learn more about this author, Raven Lebeau.
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