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Investment speed bumps (10/12/2005)
By Al Thomas


     
Maybe you have done the same thing as I have. Been driving down an unfamiliar street at night a good clip and suddenly been thrown into the air as the car hit a speed bump. You immediately slow down or even stop to put everything back together.

Kinda reminds me of trading in the stock market. Going along nicely with a particular stock or several positions when the market hits a "speed bump" and the bottom drops out. Suddenly you have a huge loss instead of a profit. You pull over to the side of the road - quit putting more money in the market. Better check to see what the damage is. How much have you lost and is it still bleeding from that terrible bump?

Unlike the car, it is going to be more difficult to put back as it was. Establishing new positions seems very difficult; however, ask any professional trader and he will tell you it is easy to buy. The secret to great financial market success is having an exit strategy. In other words when you hit that speed bump you must know what to do so as not to upset your portfolio.

The first secret is not to run too fast. By that, the pro will say not to have too much invested in any one position. Many will tell you that any position should not exceed 10% of the total portfolio. When the financial speed bump is hit no more than 10% is at risk and not even that much as an exit strategy will not allow at most 10% of that position in almost every case.

If you look at the major mutual funds you will see that the fund manager rarely has more than 4% in any one stock. Suppose you have $100,000 invested in 10 separate and diverse stocks or funds. An unforeseen event (aren't they always) strikes that stock such as an adverse finding by the FDA for a food product or a huge recall for an auto company or a bad earnings report and the stock opens the next day 20% lower thru your stop, BUT you are out and now have cash.

Let's look at the numbers. In the position you have lost 20% of the $10,000 or $2,000. That is 2% of your total portfolio. Having taken precautions this speed bump was not so bad after all. This is a pretty extreme loss, but they do occur. If you had been following each one your positions with a 10% stop and there had been a profit when the speed bump occurred you would still have walked away with a profit because the stop had it locked it.

There is no question there will be speed bumps on the road to success. Careful planning of position size and trailing stops will minimize their effect.

Al Thomas' book If It Doesn't Go Up Don't Buy It! Has saved thousands of people money in the stock market with I simple two step method. Read it and receive his market newsletter at no charge on the web site www.mutualfundmagic.com.

He is the man that Wall Street loves to hate. 

 

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