Let’s consider two systems, the first of which gains, say, 18% per year over three years, while the second system has 15% returns over three years. Clearly everyone would want the first system, right? Well, maybe not.
Imagine we dug further and found that the three years of returns for the first system were +11%, -15% and +74%. On the other hand, the year-by-year returns of the second system were +10%, +15% and +20%. From my back-and-forth with thousands of subscribers over the years, I believe that most investors would prefer the results of the second system because of the steadiness and persistent gain in wealth—especially after they’ve gone through a few jaw-dropping corrections or sour earnings seasons.
In the real world, the more volatile your results, the more faith you’re going to need to stick with a system. It’s easy to stick with the plan when all your stocks are going up; but it’s infinitely more difficult when a falling market and some bad earnings results are gashing your portfolio, especially when the pain continues for many months.
Thus, many investors are searching for a system that (a) invests in cutting-edge leading growth stocks with dynamic new products or services, and in turn, allows them to hit the occasional home run ... but (b) they don’t want to see their portfolio take enormous drawdowns during the occasional sour earnings season.
Can you have both? To some extent, I believe you can. To get there, all you need to consider are two simple portfolio management techniques.
The first is good old-fashioned position sizing. If you want to own the fastest-moving growth stocks but don’t want to live and die with every tick, then buy smaller amounts, dollarwise, of the stock at the outset.
I know that some investors get an ice-cream headache when presented with any math, but calculating a “proper” position size is important. There’s nothing wrong with owning a smaller dollar amount of a very volatile stock.
The second method is something few investors do--take partial profits at pre-defined levels. This way, you don’t have to take a small initial position ... but you will have to take some profits on the way up (dubbed offensive selling) when things are good.
There are a million ways to do this, none necessarily better than the other. But the point of partial selling isn’t really to book a quick profit (that’s all about trading, which isn’t my thing). Instead, booking a relatively small initial profit changes your mindset, and actually gives you leeway to hold on to your remaining shares through deeper corrections (because you know the overall trade will show a gain).
For example, you might buy a stock at 50, and place a loss limit at 45 (that’s 5 points of risk). If the stock rises, say, 7 to 10 points (1.5 to 2 times your initial risk), you might sell a chunk—not more than half your shares, but enough to take a worthwhile profit.
With the rest of your shares, you’d place your new stop-loss (mental or in the market) at breakeven (in this case, 50), so even if you get stopped out, the overall trade was a profitable one. With that in mind, you can then give your remaining shares room to breathe, sitting through earnings reports and some adverse moves, hoping to ride out a big winning stock.
The key in the stock market is really the outliers—your big losers and your big winners. To get the big winners, you must invest in fast-growing leaders ... but you also need a position you can hold on to for months without panicking, because big moves play out over time. The above methods can help you do that.
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