Casino & Gambling Information

Article Navigation

Click Here for more articles

Stock Market Investment Advice: Part 3

by: Dr. Steve Sjuggerud

Secret #2: Go With "Low Risk"–And Then Let Your Winners Run

You've learned that the first secret shared by 99% of the world's greatest investors is that they never–ever–allow any one of their investments to rack-up huge losses in the market. We've seen how trailing stops help there.

The other secret is that they always invest in what they call "low-risk" opportunities. Now, as you'll see, that doesn't mean their stocks or investments carry no risk or that they're not expecting very high gains from these investments. Quite the contrary.

After all, we can't make 30%, 50%, or 70% each year if we have our money in savings accounts or money market funds. Those are low-risk strategies for your money, but they're also extremely low profit. For the world's most successful investors, low risk means entering only into positions where the probability for high profits far exceeds the possibility of losses over the long run. They invest their money in such a way as to position themselves for maximum profits while–at the very same time–ensuring that their exposure to serious loss is absolutely non-existent.

A High-Profit Tool for Sophisticated Investors

"Position sizing" is really all about money management. But it's not the kind you use to make sure you have enough money on hand to pay expenses like the mortgage, household bills, college tuition for your children, car payments, etc.

The money management connected with position sizing is strictly limited to your investment portfolio. And it's every bit as crucial to your profits as trailing stops and the stocks you choose.

That's because this management process tells you how much you should invest in your positions so that you're not risking more than you're comfortable with. Position sizing also helps you when you decide it's time to add to your winning investments–a process we'll discuss in a moment.

The Marble Game

At the many seminars he speaks at each year, Dr. Tharp illustrates the importance of position sizing by having the participants play an investment game using a bag of marbles...

At the start of the marble game, participants are each given $100,000 in play money to seed their portfolio. There are 20 marbles in the bag, each one representing either a losing (black marble) or a winning (white marble) trade. There's one more interesting variable. Sixty percent of the marbles in the bag are winners while 40% are losers. And each marble is replaced after it is drawn.

One of the winners is a "10 times winner," and one of the losers is a "5 times loser."

Now, the odds of winning in this marble game are far higher than the odds you and I face in the markets. Still, when Dr. Tharp conducts this game with his seminar audiences, more than two- thirds of the participants always lose money. And a full one-third go bankrupt!

How can a majority of people lose in a game in which the odds are so heavily in their favor?

The answer is very simple: Those who lose money do so because they have no idea how much they should be investing in any one marble draw. They are playing the game without a "system," so they're really doing nothing but gambling. This sort of approach doesn't win the marble game. And, in the real-world investment game, it won't lead to long-term wealth.

The key to success they're missing in the marble game– and the strategy you should use in your portfolio–is position sizing.

Successful Investing Is Emotionless Investing

Just as we saw when we were looking at trailing stops, investors in this marble game lose money because they get caught up in the emotions of investing. During his marble game, Dr. Tharp does just what's needed to push all the "hot buttons" of his audience...

For example, after 10 pulls from the bag, he'll ask to see the hands of all those whose play-money portfolios have doubled in value. And a few hands always go up. Of course, when the others in the game–the vast majority–see that a few of their fellow participants have hit it big already, worry and envy enter the picture. And what do you think happens?

In an attempt to catch up with the winners, the other participants start increasing their bets. Problem is, when these ill-considered bets turn out to be losers, they're doomed to failure–they dig themselves into a hole they can't get out of.

Now, I'll show you how you could win in this marble game. It's the same way you'll win in the real-life investing game– the game that will determine the level of wealth you're going to attain in this life. Here's how you can pursue the very same low- risk ideas the world's best investors go after...

First of all, I'm assuming that you'll be following our investment advice and always have 25% trailing stops on your investments. The 25% is our rule–you can chose your own percentage. The most important thing is that you use it consistently!

Based on this assumption, for your investments to be low-risk, you should be dealing with odds of at least 2-to-1 or 3- to-1 in your favor, and that means you should be expecting returns of between 50% and 75% on your profitable investments.

We arrive at those figures knowing that because you'll never lose more than 25% on any one investment (you'll be stopped out at a 25% loss), 50% and 75% gains represent, respectively, 2- to-1 and 3-to-1 odds.

To give you another example, let's say you invest in a stock that you expect to return only 30% rather than 50% or 75%. To keep your investment low risk (and your odds at 3-to-1), you'd have to change your trailing stop from 25% to 10%.

Whatever your expected profits, here are two "golden rules" you should follow:

Know your worst-case scenario to keep from going bankrupt
Determine how much you're willing to lose in any one investment

Now we'll see how you would apply these two golden rules to Dr. Tharp's marble game in order to come out a winner.

You'd first have to decide how much of your $100,000 you were willing to lose on any one marble pull. Now, because you're adhering to The Oxford Club's 25% trailing stop rule, that decision won't be difficult for you–you know that 25% is the maximum you're ever going to lose. So you would never want to put more than 5% of your money on any one marble–because if you were to pull that 5 times loser out of the bag, you'd hit your stop-loss limit (5% x 5% = 25%).

You'd have to start with a bet of $5,000 (5% of $100,000). But what would you do next? Would you simply continue to bet $5,000 on every marble you pulled from the bag? Well, because the odds of this game are heavily stacked in your favor, that strategy would probably mean you'd end the game with more money than when you started.

So it would be a good strategy–but it's not the best you can do...

To really optimize the profit on your investments–in the marble game or in real life–you should scale the size of your investments to the amount of total capital you have in your portfolio.

Always Know Exactly How Much to Invest for Maximum Profit and Comfort

If in the marble game your portfolio had grown from the starting $100,000 to $200,000, and you want to stick with your 5% rule, then instead of investing $5,000 on your next investment, you'd go with $10,000. Your risk stays the same (a $10,000 investment in a $200,000 portfolio is the same as a $5,000 investment in a $100,000 portfolio), but your potential for profit escalates because you have more money in play. Similarly, if you happen to start out with some losses, you only risk 5% of what remains in your portfolio.

For your initial investment and for all subsequent investments, you should never take on a bigger risk than you're comfortable with. And you should have a systematic way of investing that ensures that no matter how the size of your portfolio changes, you'll continue to maintain that same risk level.

We advise never to have more than 2% of their capital at risk in any one position. But remember, that doesn't mean that you can only invest 2% in any one position–it means you shouldn't have more than 2% at risk.

To illustrate this 2% rule, let's look at a $100,000 portfolio. If you follow The Oxford Club's rules for 25% trailing stops and 2% risk, the maximum you can invest in any one stock at any one time is $8,000. Here's the formula for figuring that out... [(.02 x 100,000)/.25]. Now here it is "spelled out": .02 times 100,000 = 2,000, divided by .25 = 8,000.

If you decided you wanted to put less at risk–1% of your capital–our formula would be [(.01 x 100,000/.25] and your limit would be $4,000 in any one stock.

The central message here is consistency: Decide on how much you want to risk... and then stick with that number no matter what. Stay with low-risk ideas... have a consistent exit strategy for the stock market... and you'll begin to make money just like the world's greatest investors.

Let Your Winners Run–"Scale" Your Way to Ultra-High Profits

The basic reasoning behind the scaling technique is that once you've found a winner, you absolutely don't want to sell it. Instead, you want to put more money into it...

So far we've seen exactly how your portfolio will benefit from strictly following The Oxford Club's 25% Trailing Stop Strategy. And you've seen how following position-sizing opportunities keeps your capital safe while letting you rake in the maximum amount of profits available. That's a perfect combination.

In scaling in, you'll be using a similar rule to what you learned in our look at trailing stops. Only this time, instead of selling when your stock falls 25%, you'll be adding to your investment when–and every time–it rises 33%.

At about this time, average investors will begin to worry. That's because to them the idea of adding money to a stock that's rising is every bit as frightening as selling a stock that's falling. Once again, emotion has come into play, and it threatens to get in the way of your profits.

But by this time, you should be beyond that. You've seen how being afraid to sell a falling stock can hurt you, so you understand the negative role emotion can play in investing. What's more, you should be able to appreciate how investing more money into a rising stock can help you...

One of the best examples that we can use to illustrate the power of scaling in involves the French telecommunications giant, Alcatel. When we first recommended this company to members it traded at a price of $22. We rode the stock all the way up to a 108% gain before selling it on the way down when we ultimately pocketed 78%.

The fact that we gave back 25% off the stock's top didn't bother us a bit. After all, every $10,000 our members invested in Alacatel had blossomed to $17,000–and this money was safe from any further erosion in the stock's price. But here's how you could have done much, much better with Alcatel.

Rather than just sitting back and watching their winning positions climb, the world's best investors will "feed" their successes more money–so that there's more capital on the table to take advantage of the high profit that will be thrown off by these winning rides. And, of course, they always know how much additional capital to add because they're using the position sizing technique.

As you've seen, our advice is to not put more than 1% or 2% into any one stock market investment or 1% in subsequent scale-ins of that investment. In other words, you put 2% in to start the investment, and then if it climbs 33% for you, you add another 1%... another 33%–another 1% goes in, and so on. I'll illustrate this principle using a very simplified scenario, but I will use a 2% scale-in to emphasize the effective use of scaling in...

Let's suppose that after your initial investment in Alcatel–and for the subsequent 14 months–the size of your portfolio was such that 2% equaled $4,000. That would mean that if Alcatel had gone up 33%, you'd be in a position to feed this investment with another $4,000.

As we saw, Alcatel in fact rose 108% after The Oxford Club recommended it. Which means that you would have had opportunities to do three "scale-ins" of $4,000 each. This scenario is played out in the chart above.

By adding $4,000 each time this stock went up 33%, you would have maximized your profit from it during the 14 months The Oxford Club recommended it. So instead of a $10,000 investment growing to a very respectable $17,000, your total stake in Alcatel would have skyrocketed to $43,514.95!

The reason we recommend you wait to do the initial scale-in until your investment has risen a full 33% is that by that point you're guaranteed never to lose any money on the stock as long as you get out at the trailing stop. Because you'll be using a 25% trailing stop, the very worst that could happen to you at this point would be for the stock to return back to the point at which you bought it–a wash, in other words.

An Ideal Profit and Safety Scenario Unfolds...

These secrets are used by 99% of the world's most successful investors, and are now yours to apply to your own investments.

At the end of the day, these secrets–limiting your losses and maximizing your profits–seem to spring from just plain common sense. The problem, of course, is that common sense is an extremely rare commodity in the world of investing. Many investment advisors, newsletters, mainstream media financial TV shows, and Internet "gurus" make a living out of complicating the process with their own forms of investment advice, rather than simplifying it.

After all, the more complicated they make it, the more mysterious it seems. And the more mysterious it seems, the more it can play on the emotions of investors. And the more emotional investors get, the more they'll turn to these very same self-proclaimed experts for "investment advice." It's a vicious circle.

Good investing,

Dr. Steve Sjuggerud

(See Parts 1 and 2 of this white paper by searching this web site by Author's Name for ‘Steve Sjuggerud.’)

About the Author

Dr. Steve Sjuggerud is editor of the Investment U newsletter and serves as Chairman of Investment U and the Oxford Club's Investment University. He helps people become better investors with actionable stock market investment advice they can put to use to build their portfolios.

This Static Spot is open for sponsor

This Static Spot is open for sponsor