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Author: Tony Spann Article source: http://www.kabish.com/. Used with author's permission.
In his wonderful book, 'Multiple Streams of Income', best selling author Robert Allen advises Investors to divide their Stock Market investment and trading capital into three portions -50% invested long term (forever) in an Index Fund, 30% invested in Accelerated Stock strategies and 20% in options or high risk investment strategies.
This article will discuss long term investing and how technical analysis can alert us to points in time when it is prudent to take profits and exit the Stock market.
Not diversification for the sake of it, but diversification to help us sleep at night and enhance our long term returns.
Multiple Streams of Income was written in the year 2000 - the 18 year Bull market had made millionaires of anyone who bet the farm on Stocks rising forever - but investors needed an exit strategy of some sort in case the trend didn't continue, and too many of them didn't have one.
Now many are paying the price.
For years, buy and hold was a no brainer - just buy the dips and the Stock market made you rich - until it all came to a sudden end in the year 2000.
So, what do Investors, as opposed to traders, use as an exit strategy?
The weekly chart below is the S&P 500 with two moving averages, 20 weeks and 40 weeks. Charts available at StockTradingReview.com
An excellent strategy that some of Peter's friends use is to hold this Index when it's going up, and to exit or hedge your position on a moving average crossover on the weekly chart to conserve profits when it starts going down.
After all, if it's not rising in value, why own it?
Long term wealth creation demands that we prudently invest in assets that are rising in price, despite short term corrections against the major trend.
These two moving averages give a graphic display of the major trend. When the trend is up, they stay long - when it's down, they stay out, hedge their positions or go short - simple.
By placing these two moving averages on this chart, it allows even someone the age of Peter's daughter to tell him the direction the market is taking.
It protects capital that would otherwise be invested in this Index for investment in other areas, because it avoids being in this market through the downtrends.
Of course, the Index Fund managers hate people who switch from fund to fund or to cash when the trend changes.
They want investors to stay invested forever - management fees and trailing commissions may have something to do with this...
Many traders regularly receive a publication from one of the big Index Fund managers and they are always advising him that it's time in the market, not timing the market that is important - if they say it often enough then it starts to sound like it makes sense.
The chart above is graphic proof that even a 7 year old can time the market to some degree given the right tools. Charts available at StockTradingReview.com
How simple - 2 moving averages saved a fortune for anyone who was watching. Why hold something that is obviously falling in price.
The same two moving averages got investors in again when the trend turned up.
This strategy didn't give an entry signal until May 2003, 2 months after the low, but anyone who hedged or exited on the moving average crossover in November 2000 missed being fully invested during the majority of the Bear market, when many investors lost between 50% and 70% of their capital, or worse if they were leveraged.
And remember, for savvy traders this is for long term investment in Stocks, not our more speculative holdings.
This is their wealth creation money - their retirement account. This is the money they don't put at unnecessary risk.
When the market goes down like this, Fund Managers call it Volatility. They won't call it what it really is - a Bear Market!
No, investors would take their money out of Mutual Funds if the Managers said that we were in a Bear Market, and they would lose those wonderful trailing commissions and management fees.
Just call it a bit of volatility (down 50% on the S&P, 80% on the Nasdaq - volatility??) and investors will stay in for the long term because that's what their advisers tell them to do, or they will miss the bottom when it eventually comes - does that make sense to you?
Now nobody can tell for sure how far any rally will go, or if a bear market is over, until well after the event. But this simple Moving Average crossover system has kept Peter's friends on the right side of the market for many years.
They ride the up-legs of the market, and stay out of the down legs. They put their cash in Money Market Funds while the trend is down and wait for the rallies.
Another hedging strategy they often use is to buy Put options to cover their entire Index exposure - for example, if their Index fund position is $50,000, they buy long dated put options, say 12 months to expiry to minimise the time decay, to cover this level of market exposure.
They think of it as an insurance policy - they pay insurance on everything else they own, so why leave their Stocks and Mutual Fund investments at the mercy of the market - wealthy people stay that way because they protect the downside.
Time decay on options is an issue of course, but watching a long term portfolio decrease by 50% or more and doing nothing should not be an option for any serious investor.
The idea is simply this - saavy traders hold positions that are with the trend, whether it is in Property, Shares, Mutual Funds or Bonds. They do not hold un-hedged assets that are in a sustained downtrend.
Holding Stocks and funds that are going up is like riding the up escalator, it's easy to make money. By holding Mutual Funds or Stocks that are falling, it's like running up the down escalator - you have to work hard just to stay in the same place.
Then, if you stop running, it takes you right down to where you started again. This is not the way to build lasting wealth.
This is blindingly obvious - but it is amazing how many otherwise intelligent investors have lost fortunes during the bear market that started in 2000.
A smart trader's advice - put a couple of Moving Averages on the funds and Stocks you hold in your long term investment portfolio, then ask a small child what the trend is.
If they don't say up and you're still invested, all he would say is make sure you have your position hedged!
To Your Trading Success, Tony Spann and the Team
Stock Trading Review is dedicated to helping you succeed as a trader by sharing with you simple and easy to follow tips and techniques.
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