Living through the vicious 1973-1974 bear market seared the importance of risk management into my market soul. That slide, one of the worst since the 1929-1932 market collapse, taught me some life-long lessons that I'd like to share with you after 40 years in the business. As they are written from my personal experiences, keep in mind that investors use a variety of methodologies to invest and address the risk side of the investment equation and that each case is different, so please consult with your investment advisor, accountant or other investment professional for a personalized review and assessment. That said, here are my ten observations:
- Capital preservation considerations should always precede capital appreciation considerations when investing in the stock market. Always.
- Since the market goes down faster than it goes up (just as an object needs lift to rise but falls of its own weight), bear markets can inflict a significantly greater amount of damage in a shorter time period. A poignant example of this occurred back in 1987, when, in the approximately eight weeks ending with what is known as "the crash of 1987," the Dow Jones Industrial Average surrendered 46% of its roughly 660 weeks of gains from its December 1974 daily closing low (577.60) through its August, 1987 daily closing high (2722.42). Think about the rapidity of that slide. Then think about it again. What about the waterfall-like slides in many market indices from the fourth quarter of 2007 through the first quarter of 2009? The Standard & Poor's 500 Index tumbled 57% from its October 11th intraday peak (1576.09) through its March 6th intraday low (666.79). That early-2009 trough was the lowest intra-month reading since all the way back in September of 1996 – more than a dozen years earlier. And what about the plunge in the NASDAQ Composite Index from its peak above the 5100 level in March of 2000 to a low of 1108 in October of 2002? That's why having a risk management discipline before investing is so important.
- Investing in the stock market is not a business where you can afford to learn by trial and error - it's far too expensive a lesson. By the time I become smart, I can also be visibly poorer.
- Dwell on your losing trades. Not doing so, and examining the reasons for why they occurred, only serves to assure their continuance. Remember that even if you're correct nine times out of ten in your stock selections, you can still lose a significant sum of capital if you allow that one "cut" to become a financial "hemorrhage" among your holdings. Conversely, a few large gains can more than compensate for multiple losing trades.
- Be flexible, and disciplined at all times. This is far easier said than done, since, when investing in the arena of financial gladiators (the stock market), you're at monetary war daily. As one of my market mentors taught me, "the stock market teaches you humility".
- Have a floor on how much you can lose, not a lid on how much you can make. There are a few exceptions to the latter, but not the former. Additionally, if I happen to own a name that violates a technical (support) level that I deem to be of import, I sell it "at the market" in the vast majority of instances. Yes, you'll usually get that extra few cents you reach for on the upside, but the one time you don't can prove perilously costly. Don't reduce the market to a guessing game. It's your money!
- I'm an investor, not an accountant, so I don't allow tax considerations (a personal consideration) to infiltrate my investment decisions. If a stock has just several days or a few weeks to go before becoming a "long-term" holding (and receiving more favorable tax treatment), that's a situation each investor can weigh for themselves with their financial advisor. Another personal consideration is having an aversion to purchasing names which "look" or "seem" high-priced, as winners come in an assortment of prices. Far better to own fewer shares of a higher-price name that rises in price than more shares of what appears to be a "low-priced" name that declines in value. I'm a technical analyst and avoid any analytical inputs that aren't related to the supply-demand credentials (chart patterns) of the security itself.
- When it comes to dividends, I don't "put the cart before the horse." It's far more important that I concentrate on the 100% of capital I've invested in a particular security than in the 3%, 4% or whatever yield I'm receiving, since a primary downtrend in that security can claim multiple years of dividend income. Worse yet, such an occurrence could be signaling that the dividend in question is in jeopardy. To me, the best dividend is a capital gain, although I realize that investors use many different investment methodologies.
- Knowing yourself, specifically how you'll react to varying stock market gyrations, is among the key investing topics to address. Remember, not everyone is suited to invest in the stock market. As the only guarantees in the business of investing are hard work and losses, you may decide that either investing isn't for you or that you're never going to have enough of an exposure to the market to adversely affect your lifestyle should the unexpected occur. And believe me, in this business, the unexpected occurs often. Also, remember that financial losses can take a human toll, not just a monetary one. I don't think this non-financial aspect of investing is addressed to the extent that it should be. Your health and happiness come first.
- I believe that the most important aspect of the investing process is to try and identify the market's primary trend, since it's this trend within which all the other trends exist.
Jeff Weiss, CMT