In the stock market, you must have a strategy that makes you methodically cut your losses and let your winners ride. If you follow this rule, you have the best chance of outperforming the markets. If you don’t, your retirement is in trouble.
Our advice is to follow this simple plan: We ride our stocks as high as we can, but if they head for a crash, we have our exit strategy in place to protect us from damage.
The main element to the trailing stop strategy is a 25% rule. We will sell positions at 25% off their highs. For example, if we buy a stock at $50, and it rises to $100, when do we sell it? When it falls back to $75, or 25% off our high.
So with our Trailing Stop Strategy, when would we have gotten out of the muscle-shirt business? You already know the answer. Remember the shares started at $10 and fell immediately.
Instead of waiting around until they fell to $6 as the business faltered, using your 25% trailing stop, you would have sold out at $7.50. And think of it this way: if the shares fall to $8, you’re only asking for a 25% gain to get back to where they started.
But if the shares fell to $5, you’re asking for a dog of a stock to rise 100%. This only happens once in a blue moon. Not good odds!
Stock Market Investment Advice
All Stocks Can Be Risky: This one should be obvious, and if you haven’t learned it by, now the odds are that you never will. The simple truth is that every time you purchase a stock, it can and will go down. It doesn’t matter whether it’s Apple Inc. or BP, every new investment carries with it the risk of downside. How you manage those risks is the key to game. It all boils down to risk/reward.
Understand Your Risk of Ruin: As every gambler knows, the risk of ruin refers to the possibility that a string of losses will wipe them out entirely. That, of course, is completely unacceptable, since those chips are their ticket to the game. It’s no really different on Wall Street… And that means you need to protect your principal. After all, it’s your ticket to the game. Defend it at all times.
Diversify Your Risks: Big bets can make you — but don’t let them break you. Instead, it’s better to spread your risk across several different stocks; that will allow you to avoid the big draw downs that can easily come from losing one large bet on a single company.
Always Ease Into New Positions: Successful long-term investors understand the value of dollar cost averaging. This approach spreads out those stock purchases, lessening the risk that you will buy them at “the wrong time.” That way, you arrive at an average price that more often than not better reflects the true value of those shares.
Though we have many levels of defense and many reasons we could sell a stock, if our reasons don’t appear before the crash, the Trailing Stop Strategy is our last-ditch measure to save our hard-earned dollars. And, as you’ll see, it works well.
Build Your Core Positions Around Dividend Stocks: Even in bear markets, dividend-paying stocks typically do well — especially if those companies have a strong history of increasing the dividend payout. This allows you to build wealth over time as long as you pick companies with a minimal risk of a dividend cut; these stocks create your “safety-net” in volatile markets.
Always Reinvest Your Dividends: When an investor receives dividends, they have two choices: The first is to take the cash and spend it; the second is to immediately take those funds and purchase more stock. The smart investor chooses the latter. Dividend reinvestment programs are an automatic way to build wealth.
Remember the Rule of 72: Compounding is one of the powerful forces known to man — and it’s where the Rule of 72 comes in. The Rule of 72 maintains that to find the number of years it takes for to you double your money at a given rate, you just divide the interest rate into 72.
Be Content to Take a Single: Sure, homeruns are exiting… but a string of singles is just as good. Building true wealth takes time, but it’s completely achievable. For instance, did you know that a 25-year-old could turn a $3,000 a year investment into $1 million dollars in 40 years with only a 10% average annual return? Anyone can — and the smart ones do. Never over-reach.
Have a Plan and Act On it: This is the one that is easier said than done. But the truth is that when a position goes awry, it is always best to have stop-loss plan in place; this keeps losses from becoming even bigger. After all, it’s not about being right — it’s about making money.
Become a Technician: This maybe a heresy to fundamental investors, but it’s true: You ignore technical analysis at your own peril. Because while P/Es and book values definitely have their place, technical analysis is equally important to volume, price action, and chart patterns. After all, markets — just like people — repeat themselves.
Recognize Support and Resistance: Never chase stocks, no matter how tempting they may be… Instead, wait until the market falls back to a known level of price support before you buy. Spotting these levels is often the difference between a winning and a losing trade. Remember, no stock ever goes straight up.
Keep Your Eye on the VIX: The “fear gauge” tells you whether or not the markets have reached an extreme bullish of bearish position. If so, that tends to be a sure sign that the markets are about to stage reversal. As usual, “the crowd” hardly ever gets its right. (So much for the rational market theory… ) So the smart money simply uses the VIX indicator as a sign to bet against them all.
Buy When the Markets Correct: Warren Buffett said it best: “Be greedy when others are fearful.” But for some reason, retail investors just seem to hate sales. So they buy high and sell low — not exactly a winning strategy. Market corrections may be scary, but that’s the time when stocks have fallen into the bargain bin.
Nothing Lasts Forever: As bad as it may seem at times, today’s bear market will eventually run its course. After all, every bull market begins when all seems lost… Conversely, bear markets typically begin at the height of the party, and the smart money knows the difference.
Ignore the News: Warren Buffett doesn’t bother watching CNBC, so why should you? The financial news, after all, isn’t any different than your own 6 o’clock news. Drama may draw viewers, but it’s nothing more than a distraction to long-term holders. Smart investors ignore the shrieks of financial press.