“How do I manage risk in this market?”
That’s one of the most common questions I hear, whether it’s from friends and clients, attendees at my seminars or even folks I just meet on the street. I do understand why I hear it so frequently. Last year the bulls ran the market to high after high and this year the volatility has picked up dramatically.
Several-hundred-point swings on the Dow have become more common, and we’ve seen a lot of investors selling and running for the hills. That’s not a risk management strategy – it’s panic selling and will likely lead to greater losses down the road. Then there are those who sit and wait for the “right” time to invest, and thinking about the profits they’ve left on the table makes my head spin.
Let me tell you a little story: I bought my first stock 20 years ago during the height of the internet boom when the market soared to what were thought of then as unfathomable levels. It was a great time to get into investing, and the wild ride lasted a few more years before the bears finally had their say. In the 18 years since the tech rally peaked, there have been two major bear markets and several smaller garden-variety corrections. And – here’s the key – there have also been two bull markets that resulted in the S&P 500 more than doubling each time.
My point here is that if you’ve been hesitant to stay invested, trying to time the market with both buys and sells will almost always be a losing game. Stocks go up and down all the time. Heading to the sidelines during the downs or trying to avoid them generally means you’ll also miss out on the ups.
You can stay invested in stocks with big potential while also keeping your risk in check. That’s exactly why I created my NexGen system. Even in the midst of that second bull market, when the S&P was up 320%+ from its 2009 low, I continued to see strong investment opportunities. The same is true today. I still see potential with the market off its highs and stocks gyrating on a weekly basis, especially within some of the sweeping themes we’re investing in.
Picking the Right Stocks
It all starts with owning the right stocks to begin with, and then you also need a solid risk management strategy in place that protects you both on the entry and exit of those stocks. I do this through a three-prong approach that gives us a fully comprehensive picture of the stock we’re investing in and the catalysts that will take it higher. Those three prongs are fundamentals, technicals and what I like to call the intangibles.
The fundamentals look at the company itself and take macroeconomic factors into consideration, as well as things like earnings, revenue and valuation. The technicals are our second prong. Many investors are swayed by financial media hype and daily price fluctuations, but there is a way to cut through all of the noise. Charts don’t lie. They can be helpful with both long-term investments and shorter-term trading. By analyzing what they tell us, we can identify better entry and exit points to maximize our profits while protecting our downside.
Finally, the intangibles, which to me are the most exciting part of our methodology. These are the mega-trends that are reshaping our lives and our world, and right now we’re watching some of the most exciting trends in decades play out. These are the themes and catalysts that produce big gains in the years ahead – and that’s the whole idea behind my system.
So how exactly do you manage risk? For trades, I rely very heavily on charts and what I call critical support levels – price points where additional downside opens up to the point where I may need to sell. For longer-term holdings, the goal is to hold them for as long as the larger theme plays out.
That doesn’t mean we adopt a “buy and hope” or “buy and ignore” strategy – that actually isn’t even a real strategy. The key is understanding what movements in a stock are acceptable – both up and down – and at what point it’s time to move on.
I know it’s tough, but we are much better off riding out price swings as long as the expectation for bigger gains over time is unchanged. The market plays a big role in that, which we saw during the broad market correction earlier this year. Many stocks breached critical support levels as they fell, but if we had taken that as a sell signal we would have locked in bigger losses than we wanted when we didn’t have to. By holding, we were able to ride the rally back.
The best approach is to tune out the short-term noise and sell when a stock trades up to nearly full valuation based on both the company itself and the mega-trend in which it is operating. And on the downside, I will move on primarily if the story changes and the reasons I initiated the position are no longer valid. For example, if we bought a biotech stock with a potential blockbuster drug in its pipeline but then the FDA denied its approval, we would probably need to sell as the upside potential would have greatly shifted.
In the end, there is no perfect risk management strategy, but the one I use is an effective combination of chart reading, fundamentals analysis and everyday news flow. It’s a very important tool in both long-term investing and short-term trading, and it will certainly help you make more money and sleep better at night.