Six Ways to Reduce Investing Risk
A Stock That’s Behaving Well
Risk management for investing is my topic today, but I’ll start with this.
I attended an unusual wedding Saturday.
There was no church, no procession, no giving away of the bride, no maids of honor, no flower girls and no groomsmen. There was none of the traditional pomp and circumstance that so many brides and their mothers obsess over.
There was a clergyman of some sort (he had a white collar). There was a ring. There were vows, and there was a poem, written by the bride’s father, who is a professional poet and teacher.
And there was food and drink and dancing, with music coming from a laptop computer paired with a powerful sound system. In fact, the music and the drinking started before the wedding ceremony!
But what I’ll always remember is the fact that the wedding, which was held on a large dock in the fishing port of Gloucester, Massachusetts, was delayed just a bit.
And the reason for the delay was that a body had been found floating in the water!
That fact was not broadcast to all the guests, but the bride was aware of it, and it didn’t seem to bother her a bit; she’s a strong, intelligent young woman. But the news did leak out, and I thought it added a whole new layer of intrigue to the festivities, because at the time, the identity of the dead man, as well as the circumstances that lead to his death, were unknown.
Today I know. He was a 48-year-old sailor, who had stopped in Gloucester on his way back from Bermuda to his home in Yarmouth, Maine, and after mooring his 44-foot sailboat at a local boatyard, apparently had a mishap while transferring to shore in his inflatable boat.
And this incident, coincidentally, is remarkably similar to one that I originally planned to open this column with.
Last week a 22-year-old man from St. Paul, Minnesota drowned in a Wisconsin lake after a small boat carrying him and five friends capsized and he tried to swim to shore.
The same night, an 18-year-old man from Peabody, Massachusetts, who was planning to go to college in the fall lost control of his 2002 Chevy Trailblazer on the highway, crashed and died.
A few days before, a 55-year-old man from Parish, New York, lost control of his 1983 Harley Davidson motorcycle, flew over the handlebars, landed on his head and died. Ironically, he was participating in the annual Helmet Protest Run staged by the Onondaga County chapter of American Bikers Aimed Towards Education (ABATE).
What these deaths have in common is simple. They all could have been avoided if the men had done one of three simple things: worn a seat belt, worn a life preserver or worn a helmet.
But they didn’t, and they won’t get a second chance.
Which applies to investing how?
Well, from one perspective, it’s all about controlling risk.
The men above had no doubt been told more than once in their lives that they should wear seat belts, life preservers and helmets. But in these instances, they chose not to. The older man riding to protest helmet laws made a very conscious choice in not wearing the helmet; for the other two, the choice was probably less conscious.
But the result for all three was an increased level of risk, a level that proved fatal.
In the investing business, happily, even high risks are seldom fatal.
But they can certainly hurt, and the sooner you learn to identify and eliminate the greatest risk factors in your own investing, the sooner you’ll be on the path to increased profits and decreased pain.
Here are my six favorite ways to reduce risk.
1. Use market timing. When the market is in a confirmed downtrend, you should be in a defensive posture, keeping a lot of cash on the sideline or even selling short. This practice alone is a major reason that Cabot growth advisories like Cabot Market Letter and Cabot China & Emerging Markets Report beat the market averages in the long run.
2. Never buy a growth stock without consulting the chart. And then don’t buy it unless the chart promises that potential reward outweighs potential risk. That means looking for historically productive patterns like sturdy bases, high-volume breakouts and normal pullbacks.
3. Don’t invest heavily in your own employer. That concentrates risk. Just ask the former employees at the now-defunct Enron, many of who plowed all of their retirement savings into Enron stock and were left holding an empty bag. Instead, you want to spread risk by diversifying, even if it means investing in your employer’s competitors!
4. Don’t fall in love with any individual stock. It will cloud your judgment. And if you’re already in love with a company, don’t invest in it. You need a clear head to be a successful investor.
5. Cut losses short when a stock disappoints. Never let a loss grow larger than 20%; in most cases, the chart will tell you to sell it before your loss grows that large, particularly if you’ve consulted the chart before buying (see #2). And if your records show you have trouble cutting losses, use mental stops–a crude, but often effective tool.
6. Finally, when a stock you own becomes a big winner, take a little profit off the table from time to time, especially after major advances when the news is really good. You don’t want to become over-weighted in one stock; it increases risk.
Moving on … in my last column, I wrote, “Are we Americans perhaps a little too consumed by … mindless entertainment? … The fact is, we’re watching more TV than ever before, consuming more electronic entertainment than ever before, and paying crazy amounts of money to watch elite athletes play games.
“Conversely, we’re working less and reading less. Is it any wonder American students have fallen far behind their global peers and, by extension, is it any wonder the American economy is sputtering?”
I asked for your comments, and here’s what you said:
“For years I’ve been quietly complaining to my beautiful bride and family how I felt about television and the effect it has on our lives. Our conversations have turned from talking about the day’s events, family issues and plans to talking about who we think will get eliminated from American Idol tonight.
“It’s as if the events in our daily lives are not important anymore. Everything in our lives has taken a back seat to what’s on television, who was eliminated and what time the game is on.
“How does that help us achieve anything in our lives? How can you achieve any of your life’s goals when your most important goal is to schedule your routine around television shows? Frankly, we’re not being good stewards of the time we have on this earth.
“I have a quote I would like to share with you. I believe if more people read this quote every morning when they got out of bed and every night before they go to sleep, it would definitely have an effect on the amount of television being watched:
“It is on my mind every hour of every day that I have 168 hours this week to improve my life. It is really up to me to be a good steward of this time to accomplish my goals and change my life this week.”
“As western ‘civilization’ retreats from its Judeo-Christian roots and the concepts of absolute truth and of expecting life to be hard work … what is there to turn to but relativism, anti-science (can you believe the number of astrologers, palmists, crystal-gazers, Reiki, reflexology and medical pseudoscience purveyors?), and bread and circuses (aka media, politics and the relentless pursuits of leisure and comfort)? The popular answer of ‘more education’ just doesn’t cut it when there is nothing transcendent, when the traditional moral underpinnings of society are eroding/eroded daily by our society’s ‘leaders.’
“I’m a retired family doc. I just finished reading my 60th book of the year. I’m also reading through the entire Bible again, have written an 80-page book, and am editing a 60-page booklet on weight loss that I will title ‘Slim-Slow.'”
Sierra Vista, Arizona
“We need not worry about Islamic fundamentalists terrorizing our country. The structural rot caused by the limitless pursuit of good times has eroded our country’s borders, language, culture and self-sufficiency in a far more corrosive manner than any external enemy using bombs, computer hackers or viral epidemics. We seem to be following ancient Rome’s mistakes, but because history is viewed as ‘boring’ people don’t pay attention to it! How can one understand today without grasping yesterday’s lessons and context?”
“Your concerns about the changes in education and how we occupy our time are also my greatest concerns. Even more so is the lack of interest in history and especially how history and economics together reveal how societies in the past have failed. We are definitely on the road to economic destruction, thanks in large part to giant government programs that try to take care of everyone whether they want help or not, and I don’t know how we stop it.”
Olive Branch, Mississippi
“‘Bread and circuses,’ a phrase I have also used, aptly describes our current situation. My wife and I are docents for an Underground Railroad site, so I use that opportunity to make the point that slavery still exists in the world. Also, that there are people today who will take away your freedom, if you let them. Ben Franklin’s comment still applies, ‘You have a democracy, if you can keep it.’
“Most people just react to cartoon images. Ten-second commercials flooding the market win the day, while we lose the battle for American freedom and independence.”
“Like you, I am saddened by America’s lack of commitment to anything other than escapist entertainment. In that we have already seen this movie, we know it won’t end well. In the end, however, when I finally walk by myself through that last dark door, I will most certainly proceed confidently, and here’s why. Years ago there was a motivational speaker by the name of John Bradshaw. In his earlier years, he had been a falling-down, obnoxious, worthless drunk, by his own admission. One day, as he literally laid in the gutter, he looked up and had his moment of clarity. He realized, if he continued to lie there, he would die; but if he could muster the strength to rise up, he could make something of himself again. He chose the latter. The key word is “chose.” Three years ago, at the age of 62, with no warning signs, I had a heart attack. Fifteen years before that I had had my moment of clarity so I had already begun my journey (thus my encounter with Bradshaw) of learning and investigation. As an introvert, my focus turned inward, and I amuse myself by exploring the many aspects of the mind and thought. I didn’t need the heart attack to gain focus, but it did offer yet another new perspective.”
For the record, all respondents to my column shared my concern. None argued that the growing fascination with mindless entertainment was a positive force. So what are you doing about it?
As to the market, I’m very optimistic!
We’ve got absolutely horrible economic news–high unemployment, the risk that the U.S. will default on its national debt and the risk that Greece/Italy/Spain will poison the euro and set off a global financial crisis.
On the other hand, the stock market in recent weeks (with the exception of today) has performed superbly, fueled by buying power matched only a few times in the past decade.
So which should you believe, the news or the market?
You should believe the market, because the market reflects the opinions of all players with real skin in the game, and the market looks ahead.
And what could the market be so happy about? My personal hope is that the market sees a new trend toward cutting the national debt that will improve balance sheets, lead to smaller government and proportionally more market-based solutions. But what I hope for is irrelevant, and hope is not an investment system.
Chart-reading, on the other hand, is one leg of the very successful investment system used by Cabot Market Letter and Cabot Top Ten Report, and when a strong market uptrend is interrupted by a haymaker like the market threw today, I like to scan my list of favorite growth stories and see which stocks are behaving best.
Today, I like the action of Sequans Communications (SQNS), which was featured in Cabot Market Letter back on June 1, when editor Michael Cintolo wrote this:
“Sequans represents the cutting edge of chip technology, with a product line confined to 4G circuits that run smart phones, routers, USB dongles and embedded wireless modems. Virtually all of the company’s revenue comes from sales of chips that run the WiMAX system, which is essentially a WI-FI system on steroids. WiMAX systems bring high-speed Internet access to mobile devices and the global system is growing at an enormous rate. SQNS came public on April 18 at 10, and rocketed to as high as 19 when analysts added coverage with buy ratings. Sequans puts 26.3% of sales back into R&D, sports triple digit revenue growth and earnings are just picking up steam. Volatility is high, with big gains and big corrections, but SQNS is very hot.”
Since then, the stock has behaved in a very constructive manner … for a small, fast-growing technology stock. Buying volume has continued to outweigh selling volume, and the stock has calmed down as it consolidates its late-May blast-off.
Earnings will be released before the market opens on July 28, and the only question is how wonderful they’ll be.
I think buying between here and the stock’s 50-day moving average, now at 13, could work out very well.
Timothy Lutts heads one of America’s most respected independent investment advisory services. Each week, Tim personally picks the single best stock in his exclusive Cabot Stock of the Week advisory. Build your wealth and reduce your risk with the top stock each week for current market conditionsLearn More