Is the market headed up or down? … investing when you don’t have a crystal ball… the tweak to your market approach that can help generate pro-level returns
Is the market about to roll over?
Or are we experiencing the volatility that shakes out scared, weak-handed investors right before stocks surge to new highs?
What if you didn’t need to know the answer in order to invest profitably?
And as importantly, what if you didn’t need the answer in order to invest without anxiety?
You can. We’ll circle back to “how” in a moment.
First, as we look at the state of the world, the economy, and stock market today, there are plenty of reasons to be nervous. In fact, pulling money from stocks is a defensible move. (I’m not saying it’s a wise move, only that there are logical explanations for why an investor might make this choice.)
Of course, history has shown that stocks “climb a wall of worry.” And in recent Digests, we’ve pointed toward historical market data suggesting stocks will rise from here over the next year or two.
Adding to the uncertainty, yesterday’s Digest spotlighted how the S&P is currently trading at a critical long-term technical level. Which direction it breaks is likely to be the predominant trend for the near future. Unfortunately, from a relative strength perspective, that potential direction is a 50/50 toss-up.
The bottom line is that whether you’re a bull or bear, there’s plenty of evidence today to support your position.
So, how do you invest in this type of murky, risk-filled market?
Today, we’ll look at how the pros answer that question.
This answer isn’t sexy, but it has the ability to transform your long-term gains in a way that no single, high-flying stock could ever do.
It’s the blocking and tackling of investing – the fundamentals that, unfortunately, most investors never learn. But fundamentals are what win championships, and create championship portfolio returns.
So, today, let’s take a break from Russia, yield curves, and rate hikes, and look at a market approach that enables you to invest confidently – despite the risks from Russia, yield curves, and rate hikes.
***The “round trip” problem we’re trying to avoid
Yesterday, my fellow Digest-writer and InvestorPlace’s Editor in Chief, Luis Hernandez, sent me this:
You’re seeing what Wall Street calls a “round trip.”
In other words, a stock enjoys significant gains, only to lose them all.
In this case, lockdown-darling Peloton soared about 575% from October 2019…only to now be a money-losing trade over the entire period.
Peloton is far from the only round-tripper we’ve seen.
Below, we look at Teladoc going back to summer of 2019.
Despite soaring more than 300% in the months that followed, it’s now a money-losing trade over the entire period, down 5%.
Or take another pandemic sweetheart, DocuSign.
From late February 2020, it exploded about 240% higher…and then, at last month’s lows, became a double-digit loser (it’s recovered a little bit of ground since then).
We could point toward many other examples, but let’s jump to the takeaway:
What good is a huge gain if you don’t keep any of it?
All of these “winning” stocks turned into losers for investors who didn’t properly handle their position.
So, what’s the right approach that the pros use?
For that answer, we’re going to turn to a “pro” investor in his own right, our CEO, Brian Hunt.
Beyond helming InvestorPlace, Brian is an accomplished investor, trader, and teacher, having penned a series of classic investment essays which you can read here.
Not long ago, Brian added to his collection of writings, authoring a powerful, mini e-book titled, The Risk Vs Reward Manifesto.
I strongly encourage you to read the entire piece as your schedule allows. It’s highly relevant to today’s market risks.
But for now, let’s excerpt a few parts to help address the dilemma that opened this Digest.
***The one thing that various traders and investors have in common
Brian begins the Manifesto by establishing some context…
What is the risk vs. reward tradeoff, and why does it really matter?
Whether you’re a short-term trader, a buy and hold investor, a venture capitalist, a commodities trader, or a financial “mutt,” we all have one thing in common…
One thing unites us all…
That’s Risk Vs. Reward.
How you manage Risk Vs. Reward – how much money you risk on investments, short-term trades, and business deals relative to how much money they can make you – determines the long-term success of everyone in business or the markets.
It determines your success.
That’s why the mastery of Risk Vs. Reward is the most important investment and business skill you’ll ever learn.
Now, notice something…
What did Brian not write is the most important investment skill you’ll ever learn?
“Picking winning stocks.”
This should make sense to you after seeing the examples of Peloton, Teladoc, and DocuSign.
A winning stock can turn into a loser at alarming speed if not handled correctly.
What that means is the most important variable in our wealth-creation process is not our stock choices themselves, but rather, how we handle our stocks.
Back to Brian:
In every business deal, every investment, every short-term trade, and every situation that involves the potential for you to earn or lose money, you want to MAXIMIZE your POTENTIAL UPSIDE while MINIMISING your POTENTIAL DOWNSIDE…
Now, risk and reward are topics most people are familiar with.
However, the way most think about Risk Vs. Reward is ALL WRONG.
They spend all their time focusing on the wrong side of it the equation. Most people spend 100% of their time as an investor thinking about how much they can win… which is why they lose…
They don’t think for a second about how much they stand to lose if things don’t work out as planned or if the best-case scenario doesn’t play out.
On the other hand, the intelligent investor or trader – the pro – is always focused on how much money he could potentially lose on a stock, a private deal, a trade, a bond, or a piece of property.
He is always focused on risk.
***So, how do we do this? What are the nuts-and-bolts of mastering risk vs. reward?
In Brian’s Manifesto, he lays out five pillars of risk vs. reward investing:
Asset allocation… Position-sizing… Stop-losses… Bargain-hunting… and Asymmetric bets.
I strongly encourage you to read the entire Risk Vs Reward Manifesto for the details, but let’s touch on one of them – stop-losses – since this concept would have prevented the round-trip losers we highlighted above.
From Brian in his Manifesto:
When it comes to limiting risk, the powerful tool known as “stop losses” can work hand in glove with position sizing to greatly increase your odds of success in the markets.
A stop loss is a predetermined price at which you will exit a position if it moves against you. It’s your “say ‘uncle’” point.
It’s when you say, “Well, I’m wrong about this one, time to cut my losses and move on” …
Combining intelligent position sizing with stop losses will ensure you a lifetime of investing success…
If you’re trading a riskier, more volatile asset, the stop-loss percentage should typically increase and the position size should decrease.
If you’re investing in a safer, less volatile asset, the stop-loss percentage should decrease and the position size should increase.
To be clear, you DON’T have to use stop losses with your investments. You can simply use no stops but small position sizes.
***Putting it all together in your portfolio
As Brian wraps up his Manifesto, he points toward the investing legend, George Soros. Over the course of his multi-decade career, Soros made more than $20 billion from the financial markets.
Brian notes that there’s a simple mindset that’s more responsible for Soros’ success than just about anything else.
Soros once summed it up like this:
It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.
That’s the essence of risk vs. reward.
If we pull back and look at the broad stock market and economy today, there are plenty of warning signs.
That said, many specific stocks could surge in these conditions. And even the broad market itself could shake off its overhangs and head higher. In fact, history suggests that’s likely. That’s why it’s important to stay invested where your money can work for you.
But if the opposite happens and the market falls, the principles in Brian’s Manifesto will do a remarkable job of protecting your wealth.
Please make time to read it. It will give you confidence about investing today, as well as in the years to come. You might think of the Manifesto as a paint-by-numbers guide to achieving the kind of long-term returns that you usually see only from the pros.
Bottom line, it’s how you stay in today’s market without fearing your wealth will be destroyed if everything goes wrong.
Have a good evening,
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.