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Know When to Hold 'Em and Know When to Fold 'Em

by on February 02, 2014 7:30 AM

In his song "The Gambler", Kenny Rogers sang about the secrets of winning at life or perhaps at playing cards.

Country and Western music is replete with the gambling theme; playing poker being one of the old and well established ways of moving money from losers to winners.

Poker is less about gambling than it is about knowing the rules of the game and playing the odds. So it is with investing.

The rules of the investment game are not absolutes like the rules of physics, chemistry or mathematics. Investment rules are true some or most of the time and sometimes they really miss the mark.

So here we are looking into the future -- trying to perceive what the New Year will bring investors in the stock market. Since 1950, the January barometer has been remarkably accurate. "Down" Januarys have been followed by a new or continued bear market, a 10% correction, or a flat year.

The average correction was down 13.9%. That's a pretty impressive record for any investor to ignore. The year 2014 will, of course, turn out however it does, but what has me concerned is that as of yesterday (Tuesday as I write this column) the market averages are all down for the month.

The NASDAQ is down 1.88%, the S&P 500 is down 3.02%, the Dow Jones is down 3.91% and the New York Stock Exchange Average is down 3.21%. Investors should also take note that the Federal Reserve has continued tapering; taking another $10 billion off of the stimulus program, and the market is reacting negatively.

So on Monday investors should be reviewing their portfolios and looking for ways to minimize their potential losses for 2014 if the January Barometer turns out to portend a down period directly ahead. What investors need to know is when to sell their holdings and move to cash. Investor's Business Daily runs periodic articles on investment strategies, including sell strategies. Here are a few of their key points for my readers**:

  • Cut your losses short, limiting your exposure on new purchases to just 8%. If you buy a stock and it falls 8%, sell it. Don't let it turn into a big loss.
  • Lock in your gains when you have made 20 to 25% over your purchase price. Don't get greedy, especially in a year that is supposed to be a down year.
  • Don't let gains of 10% or more turn into a loser. If a stock starts to break down, sell it and book your profits. Don't wait for a short term gain to become a long term gain solely for the potential tax advantage. That short term gain might turn into a long term loss.
  • Follow the moving averages of your stock prices. If a stock declines through the 50 day moving average, consider selling. Certainly if your stock falls below its 200 day moving average you should sell it. The trend is decidedly down if a stock moves below its 200 day moving average.

There are other strategy suggestions put forth by the folks at Investor's Business Daily and I suggest that if you are a stock investor you should consider using this great investor resource. One of the more peculiar sell rules they offer is to sell when a company's CEO makes the cover of a mainstream publication. Should we call this the swelled head rule?

Good portfolio management is not confined to finding and buying the great winners that the talking heads all make note about. Rather, it includes controlling the losers so that even middle-of-the-road performers can carry the day for your portfolio.

In the last bear market the market average as measured by the S&P 500 declined 49%. By effectively cutting our losses we limited the downside for our clients considerably for that year. Let's hope we don't have another 2008 staring us in the face, but if we do, let's know when to fold 'em: to sell and move to cash for a spell. A buying opportunity always seems to show up later.

** Nothing contained in this column should be interpreted as a promise or guarantee of earnings or investment results nor a recommendation for the purchase or sale of any security or sector.

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Dan Nestlerode was previously the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. He retired in 2015 after 50 years in the investment business. A graduate of Penn State University, Nestlerode became an investment advisor in 1965. He can be reached at [email protected]
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