Daily Gains Letter

Crash-Proof Your Portfolio with These Two Investment Techniques

By for Daily Gains Letter | Feb 15, 2013

DL_Feb_15_2013_MoeOne question that hovers in the minds of investors is regarding the direction of the markets. This is mainly because they want to act before the market turns against them—eating their gains and turning them into a loss, or making losses even bigger.

Unfortunately, no matter where the market is headed, there are always experts arguing against or for it. While these experts have their reasoning for what they believe, investors are the ones who are left confused.

Should you sell your stock positions if the stock market is reaching its all-time high or will there be a breakout sending us much higher? A bullish expert might be very optimistic and argue that stock markets are going much higher—the sky’s the limit. On the other hand, the bearish analyst might argue against it.

If an investor looks at these different views, his or her ability to make a rational decision might be affected. The truth; there is too much noise in the markets.

In the stock market, or any other market for that matter, pullbacks and downturns are very normal. So, what can an investor do to make their portfolio crash-proof?

When the stock market declines, no matter how well-diversified you are, you will most likely lose money—when panic strikes in the markets, sellers flee in herds. Just look at the stock market collapse of 2008–2009. There were companies that were performing well, but, as investors sold in panic, they declined significantly.

So, what exactly should investors do when they are unsure about the market direction, and more specifically about their stock positions?

With all this noise about the direction of the stock market, investors can simply crash-proof their portfolios by following two simple rules: 1) take some profits off the table; and 2) cut your losses quickly.

Take Some Profits off the Table

Now, what does this mean? For example, imagine you purchase 100 shares of company XYZ Inc. at $50.00 per share, and the price goes to $60.00—a gain of 20%. At the same time, you are unsure about which direction the stock prices will go in the next few months—you believe the stock market is way overpriced.

In situations like this, you can bank some of the profits you have already made. You can sell half of your position—say 50 shares at $60.00—and keep the other half to ride the potential gains, if there are any.

This way, you know you have gained some profits and, at the same time, you are less exposed to the stock market or a stock with uncertain returns in the future.

When it comes to investing for retirement, these investment management techniques can help amplify your rate of return, while you’re playing it safe. The last thing a person who is planning for retirement wants is to see their savings disappear. Keep in mind, investing for retirement is a long-term process; don’t let one downturn take away your life savings. These two investment management strategies can help keep your portfolio from seeing a catastrophic drawdown.

Cut Your Losses

An investor sometimes gets attached to a stock that is making a huge dent in their portfolio. They tend to keep the losing position in hopes that it will eventually go up in value over time. It may very well be true, but before you consider doing that, think about this: if something goes down 50% in value, it has to increase 100% for you to break even.

For example, if you bought a stock for $50.00, and it went down to $25.00, for you to break even on that trade, it will have to go up by $25.00—which is a 100% move.

It can take a long time before the losses are recovered.

When you cut your losses, no doubt your losses are smaller; but, at the same time, the stress that hinders your ability to make decisions isn’t there as well. In addition, you now have some extra money that you can use to take on other opportunities.

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