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Thursday, 20 October 2005
Thoughts on Dealing with a Bear Market Correction
There are many theories about how to own stocks, when to buy them and when to sell them. Some people believe they can anticipate a correction and move their assets to cash ahead of time only to find out that they missed the rally that followed. Others believe in 'hanging in there', by riding their investments right up and right back down, believing they will be profitable over the long haul. Others, finding they have gotten their fingers 'burnt', swear off equities and turn to certificates of deposit or bonds. Let me share with you once again my approach. I do not claim this approach will be successful; this is something that I shall share with you as events unfold. However, managing your portfolio means protecting your gains, and avoiding excessive losses, if you are to be profitable over the long run.



Grandad Bluff, Wisconsin
My basic strategy is extremely simple. You are more than welcome to adapt, modify, or copy this strategy as you feel fit. Please remember that I am an amateur investor, so you would be well-advised to consult with your professional investment advisors prior to acting on any ideas I share with you on this website!

Basically, I believe that you should sell your losing stocks quickly, and your gaining stocks slowly. In addition, you should use the internal action of your holdings to dictate your overall shift from equities into cash and back again.

If you have been reading this blog for awhile, you will realize that I do this technique in my own holdings. One of my greatest failures has been to utilize margin debt in this process. It is a bad idea, although it has worked adequately for me, because debt leverages your account on the upside as well as the downside. In addition, like the "house" at a casino, the margin interest continues to rake off portions of my profits with interest expenses.

My current "rules" for investing within my actual trading portfolio are as follows:

1) Sell any new stock investment if and when it hits or passes an 8% loss. Sell the whole thing as soon as possible, even if you have held the stock for as short a period as a day or less!

2) Sell gaining stocks slowly at pre-determined %-appreciation points. Currently I use a 30%, 60%, 90%, 120%, then 180%, 240%, 300%, 360%, and then by 90% at 450%, 540%, 630%....etc. At those points I sell 1/4 of my remaining positions...rounded down to the nearest share.

3) If I sell a stock once at a gain (usually at the 30% gain point), if the stock subsequently declines, move up the selling point from an 8% loss to break-even.

4) If I have sold a stock more than once, allow it to only to retreat to 50% of the highest gain level. That is if I sold a portion at 60%, then sell all remaining shares at 30% gain point; if I sold a portion at 180% gain, allow it to retreat to a 90% gain before selling all remaining shares. Thus, allowing the best performing stocks the greatest leeway in your portfolio....allowing them to "bounce back" when the market climb resumes.

5) I do sell stocks if I truly believe something fundamentally "bad" has happened to the company. Not something like a downgrade from a brokerage house, but something more threatening like an SEC investigation, or a massive recall or slowdown in sales. I reserve the right to bail on any of my stocks, but rarely utilize this option.

6) As I have pointed out elsewhere, I like to use my own holdings as a signal to either buy or move into cash on selling. That is, when starting a portfolio, consider an eventual target # of stocks to own. I currently use 25 stocks as a maximum. You might wish to use 20 or 24. If you use 24, start a portfolio in "neutral". For me, that would be 12 positions representing 50% of the cash, and the rest kept literally in a cash money market fund. Allow yourself to drop down to 1/2 of the # of original stocks...in this case 6 issues. This is your baseline, keeping you always at least 25% invested. If those are sold on bad news, you should (imho) replace them with other solid stocks found in the same manner that I do with all of my picks. Otherwise, to increase the # of positions, requires a "signal" from your own holdings; a sale of a portion of your own stock holding at a gain point. That is if you own company "xyz", and the stock hits a first sale point at a 30% gain, this would "entitle" you to add a new position...having sold some shares on "good news". Good news, for me, is selling a portion of a stock at a gain point, indicating the health of the portfolio, and by extrapolation, the health of the market. If you sell something on "bad news", as I refer to it, either at an 8% loss after a first purchase, or at a 50% retracement of a gain, or simply on fundamentally bad news, then I would suggest "sitting on your hands", leaving that money in cash (or worse as I have done, paying down margin that I shouldn't really have), and not adding a new position. Don't compound your losses in a declining market by replacing a stock that you have sold immediately with another stock without having an appropriate buy 'signal'.

Will this work? I don't know. That is what I am trying to do with my own portfolio. I am afraid that my margin does not allow me to react fast enough. However, for the first time in my investment experience, I don't face each day with the puzzle of determining what I should do. My own stocks let me know by either reaching sale points on the downside or by signalling me to be more bullish by reaching sale points on the upside. It makes sense to me!

I hope this discussion is helpful to you! I spend lots of time talking about appropriate "picks". These stocks should only be considered (first of all after your have discussed them with a professional) but besides that, I really would want you to be "sitting on your hands" and not buying anything unless you have the appropriate buy signals from the market or from your own portfolio!

If you have any questions or comments, please feel free to email me at bobsadviceforstocks@lycos.com or just plain leave a comment right on the blog!

Bob


Posted by bobsadviceforstocks at 9:54 PM CDT | Post Comment | Permalink

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