Daily Gains Letter

You Need to Read This to Avoid Big Losses

By for Daily Gains Letter | Feb 5, 2013

DL_George_050213The S&P 500 is at a crux following its move to 1,500 on January 24, 2013, the first time the index has hit 1,500 since December 2007. The index is up 8.5% since July 30, 2012. Now the fear is that the S&P 500 may be testing its third top at 1,500 since 2000.

The stock chart below indicates some concerning points. Since its first top at 1,500 in 2000, the S&P 500 made another top in 2007; now we are precariously at a possible third top. The moving average convergence/divergence (MACD) as shown on the chart below indicates a downward trend. Volume has also been declining, so we are seeing a bearish divergence between a higher S&P 500 and declining volume.


Chart courtesy of www.StockCharts.com

But despite the positive stock market environment, this is not a time to get too comfortable in the equities market.

The key isn’t to try to time the market, as this is difficult; rather, a prudent investment strategy is to make sure you have some trading strategies in place.

You always should be thinking of the risk and your situation, and have a good investment strategy in place. A good investment strategy includes risk management, and it is the key to stock market success.

The most important tenet in trading is preserving your investable capital via the use of risk management. The last thing you want to happen to you is to trade sloppily and lose your tradable capital. You can avoid this by following some simple investment strategies.

When the price of a stock trends higher, you should think about a potential exit strategy. This investment strategy does not mean liquidating profitable trades, but rather protecting your profits.

After a surge in the stock, a good investment strategy is to take some profits. Chances are the price will retrench.

Another key investment strategy is the use of mental or physical stop loss limits. The reality is that no one is perfect in trading. I have made mistakes, and so have many of you, I’m sure.

Some of you may be wondering if the stop-loss should be a mental or physical stop. I prefer a physical stop, as it effectively eliminates the potential influence that emotion can have on your decisions when you trade. Emotion can often destroy good trades, leaving you with your losers, which is not a good investment strategy. Of course, keeping losers is counterproductive, but it will also send you to the sidelines.

For those familiar with options, you can use a put hedge to help minimize downside loss. If you own mutual funds, you can buy the appropriate index put by determining the type of fund it is (i.e. small-cap, blue chip, S&P 500, technology, etc.).

If you are already adhering to risk management within an investment strategy plan, good for you; if you’re not, learn these investment strategies, and you will become a better, more successful trader.

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