I have a 94-pound Anatolian Shepherd named Simone. She’s a great dog… She has a sensitive soul and loves belly rubs. But she’s also pretty tough. When she and Rowan, our 40-pound hound mix, get going, it’s hard to believe that she’s enjoying herself.
In other words, she is super insensitive to rough play. Most times she just rolls around while Rowan bites her neck and shoulders and hind legs.
Simone just keeps going…
That’s how the financial stock market has been for the past two years — as insensitive as our Anatolian Shepherd. Sky-high unemployment? No problem! Soaring government debt? So what! Housing still in the dumps? Who cares? We’re having fun!
Right?
You couldn’t really fight this bull market, even though it felt funny to watch stocks climb while our economy still struggled.
But we’re starting to see some conflict.
Simone loves playing, but when she’s done, she’s done. She’ll chase Rowan away, and 94 pounds of shepherd is more than enough to make Rowan hightail it out of reach.
The past few days of trading have had some sharp swings in everything from the Dow Jones Industrial Average to commodities like gold and silver. The market is conflicted… It went from being an insensitive, playful pup to a big heavyweight with teeth.
The good thing about Simone is that her corrections are short, and then she gets right back to playing.
I don’t think the stock markets are going to be as forgiving.
We’ve been saying this for a while now, but investors need to protect themselves. And the key to preserving wealth is to have those protections in place before the market turns against you.
Here’s another reason why having some safeguards is important right now.
This is a five-year chart of the Dow. You’ll see a similar chart in the S&P 500. Marked in red is a pattern called a head-and-shoulders bottom. It’s made up of three price dips. The first on the left is the first shoulder, the middle bigger dip is the head, and the third dip on the right is the second shoulder.
The peaks between the shoulders make the neckline. This is also considered the breakout point.
These patterns are bullish, and as you can see, the Dow has climbed 44% since breaking through the neckline.
Normally, according to Charles Bulkowski’s Encyclopedia of Chart Patterns, a head-and-shoulders bottom pattern climbs an average of 34% from the neckline. Right now, markets are well above that average.
This is kind of like the point where our Anatolian Shepherd Simone says, “Enough!”
Yesterday, the Dow fell more than 130 points. Oil has traded between $109 and $95 a barrel in the past five days. And gold, which had fallen below $1,480, climbed as high as $1,524 on Wednesday.
This is some serious conflict…
We’ve talked to you about having gold in your portfolio so often that this move should be hardwired into your investment brain.
So let’s look at some other ways of protecting your portfolio.
Get Rid of Risk. When stock markets are climbing, adding riskier investments to your portfolio can give your returns a boost. Ultra-conservative investors think that any risk is too much risk… and they point to market downturns as proof.
Riskier investments are often the first to fall, and they tend to fall harder than safer investments.
Smaller companies called small caps might be first on your list to go. A Forbes article recently said that money managers might be getting out of small caps, and a MarketWatch.com article suggests that prudent investors should have a good chunk of cash in addition to big blue-chip companies.
Get Out of the U.S. MarketWatch.com also said that investors should be holding emerging market companies.
This, of course, doesn’t mean you should dump all your U.S. stocks… But investors should be looking at certain international markets to add to their portfolio. You should think about adding some companies from emerging markets.
Another option would be to look for U.S. companies that do a lot of business in growing countries, either directly, or through joint ventures.
Stick to Your Stops. One of the simplest, most overlooked protections is the stop-loss. This is especially true when a long-term bull market starts to turn against you. It’s natural to want to eke out every last cent of profit, but it’s not practical, and it’s not disciplined.
Another thing — and this is something that I have had trouble with in the past — don’t buy more of a stock that’s losing. It’s called averaging down, meaning you can lower your overall buy price by buying more shares of stock when the price drops.
I was reading a letter from a friend that really opened my eyes on this. If a company’s share price is falling, why on Earth would you want to buy it?
The truth is, we’re emotionally attached to our investments, and we can convince ourselves that we’re not wrong… And that we’re just not right yet. As a result, if we think a company is worth investing in at $25 a share, then it’s an even better deal at $19.
This method can really eat away at your portfolio — and your sanity. If you’ve got money and happiness to spare, then average down all you like. Most investors will be better off cutting their losses and moving on to the next opportunity.
That’s why stop-losses are so important. They can help you take your emotions out of the decision. Pick your stop-loss wisely, based on clear reasoning, and stick to it.
Everyone talks about protecting your portfolio in clear times of market downturns. But the time to start putting safeguards in place is well before the market swings against you. We’re already starting to see conflict in the markets. Simone is just starting to show her teeth, and at 94 pounds, it’s a signal to be respected.
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