Are we months away from the biggest stock market melt-down in history? Or are we about to experience the greatest rally since the internet bubble?

Two of my favorite market analysts – Porter Stansberry and Dr. Steve Sjuggerud – have polar opposite views of where the stock market is headed.

Porter is a big-picture thinker with deep concerns about the structural integrity of today’s economy. He recently summed up his views this way:

We’re approaching a critical point in the markets… a crisis that will lead to the greatest legal transfer of wealth in history. Millions of people are about to be wiped out.”

Steve, on the other hand, doesn’t disagree with Porter’s thesis but he strongly believes that there’s a lot more upside to come before the great unraveling. In Steve’s own words,

Stocks could absolutely soar over the next 18 months, as we come out of the extremes of fear in August.

How, exactly, are mere market mortals like you and I supposed to make sense of such conflicting advice from trusted sources? It’s a lot easier than you’d imagine, I’ll bet…

Trailing stops and position sizing.

Trailing stops will get you out in time if Porter is right and – just as importantly – keep you in if Steve is right. I’ve said it many times before; most investors limit their upside potential by taking gains off the table prematurely and un-limit their downside by holding on to losers in the hopes of getting back to break-even someday.

Trailing stops do exactly the opposite. They limit your downside with reasonable stop-loss points and they un-limit your upside by keeping you in profitable positions for even bigger profits that you never expected.

This latter benefit of trailing stops was driven home to me with full force when I back-tested the performance of trailing stops on Steve’s very own True Wealth newsletter track record. I’ll never forget it.

My back-testing showed that if Steve had used a strictly mechanical 25% trailing stop strategy on his True Wealth picks from 2001 to 2013 he would have crushed his already market-beating performance. Take a look:

stock melt-down

Frankly, I couldn’t believe my eyes. I had to go back and check my code. How could a mechanical trailing stop strategy vastly improve the performance of the godfather of trailing stops?

It was all about staying in winners. Steve had done a great job of using trailing stops to get out of his losers but – like many investors – he had limited his winners by taking profits at “reasonable” levels rather than letting his winners run.

Steve, of course, understood the issue immediately once he saw these results. To his credit, he changed how he invested. I hope you will too.

Besides cutting your losers and staying in your winners, the other big protective measure you can take is to review your position sizing.

Intelligent position sizing is so critical to successful investing that I can’t emphasize it enough. Good position sizing will make sure that you don’t have too much risk in any one position.

I always knew that we tended to get emotional in our decision making around when to buy and sell stocks but one of my personal “aha’s” of the past year has been to see how emotional we also get about how much we decide to invest.

We tend to invest more in the stocks we’re most excited about and we invest less in the stocks we find less exciting (i.e., “boring”).

The impact on performance of poor position sizing can be just as devastating as holding onto a losing stock all the way to the bottom. It’s critical that you give your “boring” investments a fighting chance and you don’t allow your “exciting” investments to blow up your portfolio.

Towards the end of this article here, I described a simple view that you can configure in TradeStops to keep an eye on your position sizes and make sure that nothing gets too far out of line.

With every passing year I am even more certain that being a disciplined investor is the key to success, no matter what happens with the markets.

As I mentioned last week, I see the markets, in part, as a mechanism for transferring wealth from the many to the few. The “few” are those disciplined investors that can keep their wits about them when all around them are losing theirs.

Staying the course,

Richard_Signature
Richard M. Smith, PhD
CEO, TradeSmith
Founder, TradeStops.com