Stock Market Investment Advice
The Two Most Profitable Secrets of the World's Greatest Investors
An Investment U White Paper Special Report
by Alexander Green, Investment U Chief Investment
Strategist
Contributors: David Melnik and Michele Cagan
Investing today is not for the faint of heart.
Finding the right stock has never been harder, much less getting truly
helpful stock market investment advice. Yet investors keep plunking money down
like there's no tomorrow. Why?
For one thing, the ease of trading is like a siren's call. No longer is
investing a mysterious financial play made by only those in the know. Today,
the image of the investor is that of the day trader, an average Joe attempting
to amass a fortune from the comfort of his own computer. But ease of investing
is only a part of the story…
The real reason we keep pouring money into the markets is that we've seen
lightning strike before. We were either in on it, and loved the thrill; missed
out on it entirely and can't let that happen again; or even worse, latched onto
a tech rocket, rode it to the top, then held on until it crashed back down in a
blaze of worthless paper.
Lightning Can Strike Twice… And We Want In
Like you, we know there are winners out there still-but they're increasingly
hard to find. So when we do find a profit rocket, we want to be able to grab on
to it with both hands and ride it to the stars. Then, just as importantly, we
want to know when to get out-so our profits don't burn up on re-entry.
That's why we created 'Stock Market Investment Advice: The Two Most
Profitable Secrets of the World's Greatest Investors.'
In this special report, you will learn two of the investing secrets shared
by more than 99% of the world's most successful investors — the key to
letting you squeeze every cent of profit from your winners and to getting out
with your profits intact.
And you'll learn about a technique used by the world's greatest investors to
take your winning investment and ratchet up the profits.
Sound Stock Market
Investment Advice from the Good Doctor
Dr. Van K. Tharp is "coach" to the world's greatest investors and
traders. These superstars come to Dr. Tharp (he has a three-month waiting list
according to USA Today) for stock market investment advice that will
lift their profits to even higher levels. He was profiled in Jack Schwager's
best-selling book, Market Wizards: Interviews with Top Traders -in
fact, Dr. Tharp was the only trading coach included!
For over 20 years, Dr. Tharp accumulated psychological profiles on over
4,000 investors from all around the globe. To maintain current profile data, he
conducted many follow-up interviews with them. In addition, he has conducted
extensive, in-person interviews with many of the world's best investors and
traders.
The goal of all this work was to find the elements of investing success these
superstars had in common.What were the things they all did that helped them
pull in far more money than ordinary investors?
If he could isolate those techniques that were shared by the world's greatest
investors, Dr. Tharp believed he could unlock the very essence of investment
success.
Remarkably, Dr. Tharp discovered that these great money makers had
hardly anything in common. They invested in different kinds of stocks,
some liked commodities, others favored precious metals, many dabbled in
currencies-and almost all had their unique systems for investing.
And of course this made the two things they did have in common all
the more precious…
Dr. Tharp found that out of all the techniques, strategies, and systems
these great investors used, only two had strong appeal across the board-but
these two were used by a full 99% of these investors. In other words,
they disagreed on almost everything else.
Secret #1: Never, Ever Lose Big Money in the Stock Market
Buying stocks is easy. Anybody can do that. The hard part is
knowing when to sell. And very few people know how to do that. We've all made
expensive mistakes-either missing the full upside by selling too soon, or
taking a huge loss by holding a falling stock too long.
Let's face it. Most people don't know when to sell a falling
stock. So they're frozen into inactivity, saying, "Should I just keep
holding and hoping, or should I cut my losses now?" And there's no
reliable crystal ball to tell anyone when a rising stock has peaked. The
problem that causes both these mistakes to happen is simple: Ordinary investors
are ruled by emotions.
And the only way you're ever going to join the highest echelon of the
world's best investors is to strip all emotions out of your decisions.
Greed… fear… worry… nervousness — all these feelings have to go.
Here's our advice on how to do it…
While you'll never be able to sell at the peak each and every time you
invest, or ensure that you never buy a stock that subsequently falls
dramatically, there is a secret weapon that is proven to get you the lion's
share of any move.
When you buy a stock, you buy it with the intention to sell it for a profit
some time in the future.
In order to do so successfully, you should put as much thought into planning
your exit strategy as you put into the research that motivates you to buy the
investment in the first place.
We call this our "Trailing Stop Strategy."
All great traders and investors consistently cut losses short and let their
profits run, and Dr. Tharp found that trailing stops are one of the easiest and
most effective ways of doing that.
You, the Successful Investor
In business and in the stock market, you've got to have a plan, and you've
got to have an exit strategy. Our strategy allows us to ride our winners all
the way up, while minimizing the damage our losers can do. Before I get into
our specific strategy, consider this business example.
Discover the two most profitable secrets of the world's greatest
investors:
Let's say you're in the T-shirt business. You've made a ton of money on your
T-shirt business in the states, and you're now in The Bahamas looking for new
opportunities.
You size up the market, and you figure you can make money in two places: in
golf shirts, geared at the businessman, and in "muscle-tees," geared
toward the vacationing beach-goers.
These are two products clearly aimed at two different markets.
You invest $100,000 in each of these businesses. At the end of the first
year, your golf shirts are already showing a profit of $20,000. But the
muscle-tees haven't caught on yet, and you've got a loss of $20,000. There are
numerous reasons why this is possible, so you make some changes in your designs
and marketing and continue for another year.
But in the second year the same thing happens-you make another $20,000 on
your golf shirts, and you lose another $20,000 on your muscle-tees.
Now let's say you're ready to invest another $100,000 in one of these
businesses. Which one business do you put your money into?
The answer is obvious. You, as a business owner, put more money toward your
successful businesses. But as you'll see, this is the opposite of what 99%
of individual investors in America
do.
You, the Successful Stock Market Picker
What does "owning shares of stock" actually mean? This isn't a
trick question. As you know, it means you're a partial owner of the company,
just like you're the owner of the t-shirt company in the example. Owning your
own business isn't any different than owning a share of a business through
stock.
Let's say the shares of your two shirt companies trade on the stock
exchange. They both start trading at $10 a share.
At the end of the first year, the profitable golf-shirt company is trading
for $12 a share, and the unprofitable muscle-shirt company is trading for $8 a
share.
At the end of the second year, the golf shirt company is trading at $14
while the muscle-shirt company is trading at $6 a share.
Which shares would you rather own?
Even though you know you should buy the winning concept in this business
example, most investors don't do so in their stock investments.
They keep throwing good money after bad hoping for a turnaround. They buy
the "cheap" stock. The loser.
The Best Investment Advice You Never Hear about: The Trailing Stop
Strategy
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.
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.
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!
Advice on When to Buy Stock
Have you ever seen Coke or Microsoft selling at a single-digit P/E ratio? Me
neither. And these aren't isolated cases. The fact is, by hoping to buy
super-cheap, you would have missed out on many of the greatest investment
opportunities of our time. To make the big bucks in the best investments you'll
have to forget "buy low, sell high."
The new rule is "buy momentum, sell higher." We like
to buy companies on the way up. It usually means the company is doing
something right.
It's equivalent to your golf-shirt business in The Bahamas. Let me explain.
Let's say that you and I believe in the idea of a three-wheeled car, and the
price of the stock in the company that manufacturers them is at $30… but
falling. When do we invest? At $30? $20? $10? $5? We don't know how far this
thing will fall. We want to buy when there's some inkling of a market
confirmation of our idea.
There is no price that's the right price. Take $10 for example. I'd be a
buyer at $10 if our three-wheeled car had fallen to $5 first, and then the
stock started to take off because Ford was going to take it over. But I'm not a
buyer at $10 if it's one stop on the way down-the last stop on that elevator
could be the basement. The bottom line is this: I don't want to buy dreams
alone. I want to buy dreams that are turning the corner to reality.
We've got a complete buy and sell strategy for every single one of our stock
positions.
Here's How Our Trailing Stop Strategy Works
If you do hold onto a falling stock too long, the loss will often be far
more than just 25%. And all it takes is one big loss to set an investor back
for years.
Let's say you start off with $10,000. A year later you've made 25%
($12,500). Same for next year ($15,625), and the next ($19,530). But then after
three years of 25% annual gains, the fourth year, you take a loss of 50%. It
puts you back below where you started, at $9,766.
Now, let's say you had a 25% trailing stop during the year you lost 50%. You
would have been stopped out at $14,648. Then during the following three years
(when you again profited by 25% each year), your holdings would be $28,600 at
the end of that entire seven-year stretch.
However, if you didn't have a 25% trailing stop in place, after the same
seven-year period, you would only have $19,073, still below where you were
prior to the 50% drop!
Over the seven years of this example, you'd be up 186%. That's an average
return of over 26% per year, much better than you'd think. But pick your own
example, and do the math. Look back at your own portfolio. You'll see that
cutting your losses is the key to both getting good overall returns and
avoiding lost years.
Examples from Our Files
Let's begin with a look at Adobe, the innovative software
company on the Nasdaq that we once enthusiastically recommended. It
zoomed up, with no sizable price correction, for 10 straight months. The stock
kept achieving new all-time highs. Along the way we kept adjusting upward our
25% trailing stop. Given that we bought in at $31, we kept locking in higher
and higher profits.
When the technology and
communications sectors finally began to correct, Adobe corrected along with
them. But thanks to our 25% trailing stop, the worst-case result turned out to
be a profit of over 81%.
Contrast this approach to the "buy and hold" strategy. The Nasdaq
high techs had an amazing run. But when they began to unravel, things got ugly
in a hurry. Compare our profit of over 81% to the devastation that occurred
among other high-tech stocks during the same 10-month span. Amazon was
down 60%, Qualcomm down 63%, Intuit down 66%.
Several companies witnessed declines of as much as 90%, and the "buy
and hold" crowd held all the way down. That's what can happen when you
hold a stock investment with no exit strategy. That kind of loss is hard to
recover from. Just look at the chart above, and you'll get a good feel for the
kind of long-term damage just one bad stock can do to your portfolio.
Hang on too long… and it could take years to recover your loss.
In reality, most investors who say they're buying and holding will in fact
panic in a bear market, especially a long grinding one. We saw it graphically
in the recent "Great Recession." Don't let this happen to you: Use a
smart exit strategy that lets you capture the majority of any profits-even a
doomed one.
The System Is Not Fool-Proof
As good as the trailing stop concept is, it's not perfect. For one thing, in
particularly volatile stocks, you can get stopped out at a price much worse
than you had hoped for.
Take Microsoft as an example. As stories circulated that the Justice
Department was proposing a court-ordered divestiture of the company, its shares
experienced serious volatility. Before the ruling the stock was trading at $79.
The next trading day, Monday, the stock opened at $67.
Even if you had a $75 trailing stop in place you would have had to sell at
$67 because that was the next available market price to execute the trade.
Once a stop price is triggered, it becomes a "market price" sale,
that is a sale at whatever the market will bear. Normally that won't be a big
problem, but sometimes volatility can make your target price impossible
to fill, as in the Microsoft example.
Domestic U.S.
stock markets do not accept trailing stop orders. And for thinly traded stocks,
they don't even accept "hard" stops. Exchanges outside the U.S. seldom
accept any stop orders at all. (Trailing stops move constantly based on the
stock price. Normal "hard" stops are put on at a particular price and
remain regardless of what the stock does.)
Trailing stops are changed according to what the stock does-the higher it
climbs, the higher the trailing stop is moved.
If exchanges won't accept these orders, there are two alternatives. Both are
mental stops, either put on by you or by your broker. Either one of you-or
both-must be on top of the situation-always.
Value Trading-When the Trailing Stop Might Work Against You in the
Market
By its very nature, value trading can work against the trailing stop. Value
trading-the system of buying strong companies at or near historical
lows-implies that you may temporarily follow a stock down past a trailing stop
before it begins to rebound. With a trailing stop in place, you may never see
the rebound.
And this happened to us recently. We recommended Debt Strategies
Fund as a good way to play the beaten-down, high- yielding corporate
bond sector. At the time, it was priced around $7. But, more importantly, it
was yielding over 16% annually.
However, about nine months later, we came full circle with breaking stock
market investment advice. We advised members to disregard our trailing stop for
this investment. Why? Because at that time,
Investment Director Alexander Green valued the income-producing yield more than
the price-per-share dip. And he thought the chance for the fund to dive
significantly below our trailing stop was remote. So, when the price dipped
below our $5.80 trailing stop, we held on.
With no trailing stop strategy, there was no guarantee that we would stop
losing money on this investment if the stock continued to slide.
We might have lost 60%, 70% or even more.
Fortuanately, the fund behaved like Alex thought it would. The price per
share quickly rebounded to over $6 in just a few days.
So we need to carefully consider value trades in light of the trailing stop.
JDS Uniphase: A Perfect Run-Up in the Stock Market
And now we've come to our quintessential example of the power of the
trailing stop:
JDS Uniphase.
Even though the story is over a decade old, it defines the profit-making
power of trailing stops like no other. In March of 1999 we heartily recommended
JDS Uniphase. We said then that "it would be the company that would create
the next great fortune," and it "is one stock investment that you
don't want to miss."
We placed the normal 25% trailing stop on it.
It turns out this was sage advice, as the stock had a perfect, even
breathtaking, run-up. It rose from our recommended price of $10.95 (split
adjusted) to $110.12-a whopping 905.66% in 14 months. But amazingly, during
that entire stretch, the stock never had a real pullback in the market.
Without the 25% trailing stop strategy, it would have been tempting to sell
some or all of it at 100% or 200%. Had we done that, we would have missed out.
When the stock reached $150 we were still in it, and subtracting 25%, the
lowest price we would sell this stock would be $112.50. As it turned out too,
$150 was the high point
for the stock. Of course we didn't know this at the time, nor did anyone else.
But that's the great thing about the trailing stop system — it takes the
"guesswork" out of trying to determine a stock's value. We let
the market tell us when the run is over.
The trailing stop system always keeps us from losing our shirt and always
locks in our profits when a stock has had a significant gain. How many times
have you heard of investors saying they made 100%, 200% or more-only to give it
all back when the stock corrected? That's not happening with our system-sure,
we may give back a little, but we're always locking in profits on our winners.
If JDS Uniphase had continued to rise above $150, we would have been along
for the ride. But in this case, $150 was the top, and it gives one a great
feeling knowing that even if the worst were to happen-a stock collapse-we would
have a huge 905%+ profit. That's the beauty of the 25% trailing stop strategy.
The Rest of the Story: Don't Buy and Hold
JDS Uniphase also provides a dramatic example of the benefits of our system
versus the perils of holding and hoping. As we said above, we took more than
906% profits from this investment. JDS was a grand slam for us.
Unfortunately, for investors who don't use a trailing stop strategy, JDS is
also the perfect example of the "big fish that got away." From its
high of more than $150 per share, the stock went on to plummet byabout
97%. That's the power of a trailing stop strategy — it can mean the
difference between taking more than 900% profits and losing 97% of your
investment's value.
Use Daily Prices in Your Stock Market Investment Strategy
We use end-of-day prices for all our calculations, not inter-day prices. You
should too. This makes things easier. If a stock has gone to $100, put a mental
stop at $75. If, subsequently, the stock closes at or below that $75 level,
sell your shares the next day.
Remember, the key is discipline. A trailing stop is a good technique. Stick
to it. Choose a broker who understands trailing stops and will do the work for
you.
But common sense dictates two investment fundamentals:
- Taking small losses is much
better than taking big losses.
- Letting your profits run is
much better than cutting them off prematurely.
Using trailing stops is the best first step you can take to greatly improve
your portfolio's return.
Follow this time-tested technique of the world's greatest investors and your
investments will outperform those of your friends, neighbors and even your fund
managers.
This is the first step to having a coherent, reliable system that will let
you sleep at night and give you the satisfaction of knowing you're maximizing
your profits.
Once you apply trailing stops, you'll be that much further ahead of the
ordinary investor.
Secret #2: Go With "Low Risk"-And Then Let Your Winners
Run
The other secret is to always invest in what they call "low-risk"
opportunities. Now, as you'll see, that doesn't mean their stocks or
investments carry no risk or that they're not expecting very high gains from
these investments. Quite the contrary.
After all, we can't make 30%, 50%, or 70% each year if we have our money in
savings accounts or money market funds. Those are low-risk strategies for your
money, but they're also extremely low profit.
For the world's most successful investors, low risk means entering only into
positions where the probability for high profits far exceeds the
possibility of losses over the long run.
They invest their money in such a way as to position themselves for maximum
profits while-at the very same time-ensuring that their exposure to serious
loss is absolutely non-existent.
A High-Profit Tool for Sophisticated Investors
"Position sizing" is really all about money management.
But it's not the kind you use to make sure you have enough money on hand to pay
expenses like the mortgage, household bills, college tuition for your children,
car payments, etc.
The money management connected with position sizing is strictly limited to
your investment portfolio. And it's every bit as crucial to your profits as
trailing stops and the stocks you choose.
That's because this management process tells you how much you should invest
in your positions so that you're not risking more than you're comfortable with.
Position sizing also helps you when you decide it's time to add to your winning
investments-a process we'll discuss in a moment.
