Posts Tagged ‘Investing’

Beginning Investing – Safe Investing

Using Protective Stops To Limit Risk

If your portfolio went south over the last few months the chances are that you had a broker with a big firm who bought you mutual funds using a “buy and hold” strategy. That means in the long run stocks will make money, so do worry if they drop a bit. It’s stupid… and they do it because it is a lazyman’s strategy. On the other hand, if you got out of stocks and into cash sometime after June 11, 2008, the odds are that you or your broker bought stocks with a stop strategy. So, in my book that makes stops a good thing.

So what are stops? Well its a very simple idea… and let’s take the simplest case when you are expecting (or hoping) the value of the stocks to increase. In that case, a stop sets a minimum value to which you will allow the stock to fall before your automatically sell it. Fo,r example if you purchase a single share of stock for $100 and set a stop at $90, then you are saying that if the stock hits $90 it should be automatically sold. That means that you control your risk in purchasing the stock to 10%. You’re not actually risking the full $100.

The diagram at the right will give you the picture. The jagged line represents the value of a stock. Like any normal stock there are days on which the value goes up and other days on which the value goes down. You decide to purchase it when it has the value shown by the circle on the left and the horizontal line tagged Purchase. Using the stop strategy you immediately set a stop value to control your risk in purchasing the stock. Now, as the diagram shows, the trick is in finding the right value. Notice the line tagged Stop 2. If you set your stop at the value you would have lost money on the stock because it would have automatically sold at the point represented by the second circle from the right… and you would have lost (Purchase – Stop 2) dollars. On the other hand, look at the line tagged Stop 1. This value for the stop allowed the stock to take a normal downswing in values, but then rebound and continue higher. So, the real trick is to figure out what normal ups and normal downs are and set your initial stop value below the normal downs. There are different strategies for doing that based mainly on your investment philosophy. However, notice that the bigger swings a stock typically takes, the larger the risk to you… and, yes, that becomes one factor in evaluating which stocks to purchase at a given timYe.

You can’t just set a stop and then forget it. You need to check it routinely and adjust it… and one of the most simple strategies for adjusting it is that when the value of the stock goes up you raise the value of the stop, but when the value of the stock goes down you leave the stop alone. So, as the stock increases, the stop value goes up and your risk diminishes until finally you hit the “holy grail” and your stop value is greater than the purchase price. This is shown by the line tagged Stop 3, and when that happens you are guaranteed to make a profit on the stock. You no longer have any risk. The stock may continue to rise in value or, as in the diagram, it may fall. The beautiful thing is that when it falls it automatically sells at your guaranteed profit value. That’s shown in the diagram by the circle on the right. In the diagram, the profit on the stock was (Stop 3 – Purchase) dollars.

From this brief discussion, it should be obvious how stops can save you from catastrophic failures in stocks like we have seen in recent months. Don’t buy the line of baloney from your broker about buy and hold. Protective stops could have saved you the last 5 years in profits.

Please share with your friends

Hide Sites

Posted in Investing

A Simple Strategy For Better Investing

Mutual Funds Stink

Let’s face it. You’re not going to enjoy your world if you’re broke. I’m not an investment counselor or a broker, but I do know that paying attention to Vector Vest certainly saved my rear end in the latest stock market debacle. For years I have been getting the classic “buy and hold” advice from my brokers at big time, name brand brokerage firms… and, as those of you who actually did hold on to your stocks after June 11, 2008 know, if I had listened to this advice I would have seen a huge loss that basically wiped out the gains of the last few years. In my book, that really stinks.

I Found A Better Way to Invest Money

In early 2007, I found out about a company called Vector Vest about the same time I started listening to Courtney Smith about investing and opened an account at Scottrade. Courtney told me that the buy and hold strategy does produce better results than sticking your money in a savings account, but is really not a very smart way to invest your hard earned cash. He said that it’s really a better idea to buy and sell individual stocks… but the buy and sell strategy doesn’t really work with the big brokerage firms because they charge too darn much for individual trades. It’s ridiculous… hence, the account at Scottrade. There is nothing really magical about Scottrade. Just get an account somewhere that costs less than $10 a trade. Scottrade is $7.

I’m not the kind of person that likes to sit in front of a computer screen all day and watch stock prices, so I had to find a strategy that would allow me to just check stocks once a day for a few minutes… and, frankly, my opinion is that if you’re not willing to do that you aren’t really serious about wanting to improve your investment strategy [yes, there are some other alternatives I will discuss in future posts].

A Really Simple Investment Strategy

It works for me!

I found a really simple strategy – and that’s important – when I ran across Vector Vest. Take a look at the following 3 year chart.

This chart is the Vector Vest composite index, which is made up of over 8,000 stocks. I think is really a better indicator of what the entire market is doing than the Dow or NASDAQ. Take a look at the big blue dotted line. This is what happened to people who followed the buy and hold strategy. They lost money over 3 years… so, literally, it would have been better to stuff your money in a mattress.

Now take a look at the vertical red and green lines. Those are the Vector Vest confirmed market downs and ups. The confirmed ups in green are the buy… buy… buy times [thank you Jim Cramer] and the confirmed downs in red are the sell… sell… sell times [boorah!]. The solid red arrows on the chart represent the times that you would make money following this simple strategy. You might notice that there is only slightly improved performance by following this strategy over the buy and hold technique between October 31, 2003 and October 12, 2007… but then the market starts to fall. Following the simple Vector Vest strategy avoids the subsequent crash. In fact, you make a little money between April 11, 2008 and June 11, 2008 before completely avoiding the really big drop beginning in mid June. Not bad eh?

Improving The Strategy with Counter ETFs

Now let me tell you about a slight addition to this simple strategy based on what are called Counter ETFs. These are funds that are designed to increase in value while the market is falling… but you don’t have to know a thing about selling short. You just buy them like you would any other stock. It’s simple. Now take a look at the solid blue arrows on the chart. Those are times when the market is falling… but the Counter ETFs are increasing in value. I hope you’re getting the picture here. You can make money both when the market is rising and when the market is falling if you sell Counter ETFs and buy stocks when you see a confirmed up and sell stocks and buy Counter ETFs when you see a confirmed down. So, in the chart, you make money whenever you see any solid arrow. Pretty nice! All you need to do is add protective stops when you buy.

Of course Vector Vest also gives you tools to pick which stock and which Counter ETF to buy. More on that and protective stop strategies later. By the way, today, October 30, 2008 is the wrong time to jump into the market. For this strategy to work, you’ve got to time it with the confirmed ups and downs.

Please share with your friends

Hide Sites

Posted in Investing