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Time to Double DownBy
Friday, February 5, 2016
The markets are a mess. It's time to double down.
No, it's not time to double down on your losing positions. It's time to double down on your commitment to being a disciplined investor...
It's a serious time. And while I'm personally skeptical of the full-on bear market case, I am fully prepared to be proven wrong. And I've made sure that if I am wrong, I won't get hurt too badly.
Making sure that you don't get hurt too badly when you're wrong is the great secret to ultimately succeeding as an investor. You've got to be in a position to live with your losses. You can't allow the markets to dictate your emotions. You can take risks, but you need to understand the risks you're taking... and be comfortable with them.
In today's essay, I'll show you exactly how you can do that...
I once asked an early mentor of mine, a 40-year veteran of the markets, "What's the difference between the winners and the losers in the markets?"
I'll never forget his reply: "The winners don't need the money."
You can't risk more than you can afford to lose. It's advice that I took to heart. You should, too.
Yes, we all want to grow our wealth through investing in the capital markets, but that happens gradually, over time. It takes patience... and you can't get there without a solid risk-management plan.
Given current market conditions, it's especially important to know how to manage market risk.
At the heart of any great risk-management plan is trailing stops. Long-time DailyWealth readers know that smart trailing stops are an effective investment tool for risk-management for individual investors because they limit losses and let your winners run.
I recommend using a simple 25% trailing stop. It's a time-tested strategy which, backed up by my extensive back-testing, has proven to be an effective risk-management system over and over again. It's widely used by experts like Steve Sjuggerud and Stansberry Research founder Porter Stansberry.
Let me show you how effective the 25% trailing stop is by using one of the hottest stocks of the past few years – Valeant Pharmaceuticals (VRX) – as an example.
Let's say we bought shares of Valeant back in August 2014 for around $120 a share. About a year later, shares were trading for a little more than $260 – a gain of about 120%. Our trailing stop hadn't been triggered... we were simply letting our winner run higher.
But as any investor can tell you, stocks don't move straight up forever. Eventually, Valeant hit a rough patch.
In October 2015, we stopped out of the trade for a 67% gain. We sold when the trailing stop told us to sell. And it's a good thing we did, because had we ignored our trailing stops, we would be sitting on a near-20% loss today. Take a look:
 As you can see, the trailing stop helped us lock in our profits before shares crashed. It took the emotion out of our investing. Sure, we didn't sell at the exact top... but we aren't sitting on a big loss today, either. And we can live to trade another day. Now that you see how trailing stops work, are you ready to double down on your commitment to be a disciplined investor? Are you ready to take advantage of these market conditions?
Using trailing stops is the best way I know to protect your investments and grow your portfolio safely.
Good investing,
Richard M. Smith, PhD
Further Reading:
In October, Porter Stansberry explained another crucial part of successful investing: risk-adjusted position sizing. "This idea is the single most amazing thing I've ever learned about finance," he says. "It's simple. It's incredibly safe. And it will make you truly huge amounts of money." Get all the details right here.
DailyWealth classic: Following your trailing stops is one of the foundations of successful investing. See how the strategy helped Matt Badiali's subscribers book 542% gains in just 10 months, here.
Market NotesTESLA HEADS LOWER Today's chart is another reminder to avoid flashy, "story" stocks...
The story is electric-car maker Tesla Motors (TSLA). Over the past few years, Tesla has become one of the world's most popular stocks. People love Tesla's genius CEO, Elon Musk. Investors love the idea of driving electric cars. For a while, Tesla shares could do no wrong. They climbed from $30 in late 2012 to a high of $286 in mid-2014, a gain of more than 850% in less than two years.
But as we mentioned last month in our bearish warning on 3D Systems, when everyone falls in love with a stock, its valuation goes through the roof. Eventually, these stocks will hit a rough patch. And when that happens after a stock is priced for perfection, watch out...
We can see this in the chart below. Tesla had a great run, but now shares are sinking fast. The company is down 35% since July. Shares have fallen more than 20% in the past month alone... hitting a new 52-week low yesterday. It's yet another reason to avoid the "investment herd"...
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