Most of us accept that stock markets are risky, but don’t want to get hammered when all hell breaks loose. There are several things you can do to ease the pain in torrid times, but their appeal will depend on factors such as your attitude to risk, why you are investing and what has happened to stock markets by the time you read this.

Starting with cash
The only sure way to protect yourself from market storms is to put all your money into cash – although with banks in disarray, even that is no longer a guarantee.
Clem Chambers, chief executive at stocks and shares website Advfn.com, has done exactly that: ‘Earlier this year, I was convinced stock markets were heading for a mighty fall, so I liquidised my entire portfolio and put everything into cash. That’s the only way I could see of protecting myself, and so far I have been proved right.’

To take such a drastic step, you have to be sure markets will fall. ‘If you have £100,000 in stocks and shares, selling everything will cost plenty in commission and spreads, especially with small caps. You have to be absolutely certain that any problems aren’t just a blip.’

And Chambers is in no hurry to return to the market. ‘They will struggle for at least six to 12 months. After that, it’s anybody’s guess. Brave investors might put some money into banking stocks, but they should be careful. Just look at Bradford & Bingley. Right now, cash is the best defence.’

So Chambers has called the market correctly, but with the FTSE 100 down more than 20 per cent from its recent peak of 6730, it’s probably too late for the rest of us.

In any case, cash isn’t without its risks, says Elliot Farley, analyst at fund manager T. Bailey. ‘Quitting the market may look like the safe option, but it can backfire. It takes time and money to liquidate and reinvest your portfolio, and you could easily get caught out if markets take off again. We always try to stay fully invested.’

Farley says an investor who missed the single best trading day in the market for each of the past 20 years would almost halve their annual returns from 6.9 per cent to just 3.8 per cent. ‘If they had missed the two best days in 2007, their returns would have gone from positive to negative. But at least if you withdraw from the market, you know what you’ve got.’

Turning to bonds
Corporate and government bonds are seen as a safe haven in choppy seas, but is this still true? Corporate bonds have been out of fashion for ages, but a few months ago they were on the verge of coming back, says Ben Yearsley, investment manager at Hargreaves Lansdown. ‘Investment-grade bonds were paying yields of seven per cent,
plus the chance of capital growth, and suddenly looked attractive.’

Then inflation reared its ugly head and the downward pressure on interest rates shifted into reverse. Yearsley adds, ‘Bonds pay a fixed rate of interest, making them less attractive when rates are rising. This had a negative impact on bond prices.’

However, he suggests bonds haven’t endured the same sort of hammering as equities, and could still be a good way of protecting your portfolio: ‘When interest rates start to fall again, perhaps later this year, bonds could surge back into favour. They still yield seven to eight per cent, and you could enjoy good returns over the next few years.’

Secure dividends
What about dividend-paying blue-chips? Once-solid household names have been offering tasty yields lately, including Alliance & Leicester (20 per cent) and Marks & Spencer (13 per cent) but, as you may have noticed, these companies are also on the ropes. Share prices have plummeted making them vunerable to takeover and this pushes up the yields to ridiculous levels, says Nick Raynor, investment adviser at The Share Centre. ‘They can’t continue to pay these yields, and will have to slash rates. If not, people will ask why they’re giving money to shareholders instead of investing it in the business.’

BT, GlaxoSmithKline and Vodafone are possible exceptions. Raynor says, ‘These stalwarts have seen share prices fall and yields rise, but less dramatically. They could still offer good value over a three-year term. Or you could choose traditionally defensive sectors such as utilities. We still recommend United Utilities, Scottish & Southern Energy and National Grid, but nothing is guaranteed in the current markets.’

Booming sectors
Some countries are proving immune to the rash of tumbling stock markets around them. Why not switch to healthier climes?

Eastern Europe, particularly Russia, is still blooming, says Claire Simmonds, client portfolio manager at JPM New Europe: ‘Russia is the largest producer of oil and gas, and the eighth-biggest producer of gold. It was the third-largest contributor to global GDP in 2007, behind the US and China.’

Or target a booming sector such as energy, where sky-high oil prices are firing company earnings, says Robin Batchelor, who manages the Blackrock New Energy Investment Trust. ‘Energy stocks are in a good position to perform well beyond 2008. Earnings should remain buoyant as prices remain high, supported by lacklustre supply growth and booming demand from emerging markets.’

Getting the balance right
Instead of hopping between sectors, you could protect yourself through asset allocation. Bonds, commercial property and stock markets perform well at different phases in the economic cycle. Spreading your money can steady your portfolio, says Andrew Wilson, head of investments at Towry Law.

‘A year ago, equities and commercial property were still storming ahead, but government bonds are made for markets like today’s. Careful asset allocation will balance your losses and help you sleep at night.’ Wilson says this is safer than trying to time the market: ‘The danger of selling equities is that you miss the bounce back and pile into the market when it is 1,000 points higher. Asset allocation removes that risk.’

But you have to rebalance your portfolio regularly, and Wilson argues that shifting profits from the strongest asset class should leave you nicely prepared to meet changing trends. ‘We would typically put 60 per cent of a growth portfolio in equities. If markets perform strongly, we would reinvest the profits in other asset classes, to avoid ending up with 75 per cent of the portfolio in equities just as markets peak.’

He adds, ‘I believe in “mean reversion”. At some point, a top-performing asset class will revert to the mean. If you have been shifting your profits into an asset that hasn’t performed, when prices are cheap, you will have plenty of dry powder when it takes off.’

Stopping the losses
If you’re trading in direct equities, consider setting up a stop-loss, which automatically triggers a sale if the share plunges by, say, ten or 20 per cent. Nick Raynor at The Share Centre says a host of traders now regret failing to set one up.

‘A number of clients are kicking themselves for failing to take our advice. But if you set up a ten per cent stop-loss on a stock that opens at, say, £1.50, tumbles to £1.30, then rallies to £1.60, you will have lost out by selling the stock at £1.35, so you have to be careful.’

En attaque!
Attack, they say, is the best form of defence, so why not cash in on current turbulence by chasing markets down? More adventurous investors could take a spread bet on a falling FTSE, by gambling £10 for every point it falls. At the time of writing, the FTSE 100 has shed over 150 points since breakfast, so a £10 per point spread bet would have netted a tax-free £1,500. Not bad for a morning’s work. But of course, if it had shot up by 150 points, you might have struggled to eat your lunch.

You can adopt a similar strategy by taking out a contract for difference (CFD), but whichever option you choose, make sure you know what you’re getting into, and protect yourself with a stop-loss. Otherwise the current chaos could turn into a rout!