December 28th, 2006: Today was the next to last day of trading this year, and for the second day in a row the Dow closed above $12,500. The market was slightly lower today, with the Dow shedding $9, the Nasdaq losing $6, and the S&P 500 dropping $2. Most of the movement in the market this week has been on very low volume. This means there has been a lack of liquidity driving stock prices. If you look at most of your portfolio, I'll bet you see that all of your stocks were trading at half their normal volume.
This has some consequences for all of us little guys. It means, that stocks that dropped on this low volume probably dropped a little too much, and stocks that went up, probably climbed a little too high. So, don't worry if the start of 2007 is a little bumpy.
This year was a good one. All of the major indexes were up. The Dow up 15%, the S&P500 up nearly 14%, and the Nasdaq up about 6% after being down nearly 15% by the end of the year. All in all, this was a ridiculous year. For me personally, I was flat until August. I had a couple of bad trades early with large caps. However, assuming no major market move tomorrow, I am going to end the year up 12% in my 401k, and 28% in my trading/investing account. I'm not going to pretend that I can duplicate these gains every year, but I think all of us can beat the market if we think about it. That's why I'm going to lay down some rules.
Jim Cramer has put out two books; one with 25 rules, the other with 20 rules. I'm not going to pretend to understand the market as well as Cramer, but I am going to lay down some "rules."
(1) Don't be afraid to be all cash or all stock - if you are confused and don't know which way the market is going, and don't have any good ideas, don't be afraid to sit on the sidelines for a little while. If you're not comfortable shorting a falling bear market, be happy while sitting in a bank CD making 5%. Conversely, if you have several good ideas, don't be afraid to move it all in and be stock heavy... just don't get overconfident.
(2)Diversify! - Never have less than 5 stocks in your portfolio, and never have more than 40% in one stock. If you only have one good idea, put 60% in a mutual fund and invest the other 40% in your extremely great idea (if it's less than extremely great, don't be that far in!!!).
(3) Know when to walk away - I like to use trailing stops. Use stop limits if you want. One of the biggest mistakes any of us will ever make is to hold onto a loser too long. There are some positions I don't worry about too much. For example, when Pfizer (PFE) dropped 11% in one day on the torcetrapib bomb, I didn't pull out? Why not? I knew PFE would bounce back, and they nearly have. However, if you are invested in let's say Cepheid (CPHD), which I advised earlier, and you see it drop 5%, get the heck out! For example, I rode CPHD to $9.50, and set my trailing stop at 3%. This meant when it dropped to $9.20, I was stopped out. Good thing, because it ended updropping to $8.40, which would have meant a loss. So, for large caps? Maybe you can wait out pain... especially with big dividend companies. However, with these little guys, be prepared to jump ship in a hurry if need be.
(4) Don't buy stocks less than $5 - That is, don't buy them unless you have a really good reason to. For example I bought Jed Oil (JDO) recently because I have a good reason to believe they are going to go back to $10/share. However, stocks that are less than $5 are often ones that tank the fastest.
(5) Don't avoid risk - Just know how much you can take! If you can stand a moderate amount of risk, don't hesitate putting up to 20% of your portfolio in riskier stocks. On average, you may make 7-8% a year with index funds, but your opportunity to double or even triple your money comes from more speculative plays.
(6) Don't buy too little - Even the cheapest trading platforms cost you $7/buy and another $7/sell... this means $14 to get in an out. So, if you buy let's say $200 dollars worth, you have to make 7% to break even! This in not tolerable! I personally believe that you have to put at least $1000 into any position to avoid getting killed on commissions. The only time you can put in less is with a very risky stock. If you think one of your position might jump by 50% (up or down), then sure, you can go with less, to limit risk. However, I would still buy more and just set very tight limits to avoid big losses.
(7) Watch earnings closely - When earnings season comes around, you should listen to the conference calls of every company you own. This will give you a feel for how the company is going to do in the future. Also, know what the analysts are predicting... is one analyst skewing the average with an obscenely high or low earnings prediction?
(8) Know the Fed - I don't know of anyone who invests heavily and reads the news who doesn't know what the Fed is likely to do (I say likely b/c we're never positive). I haven't missed a prediction since 2003 on what the Fed was going to do. Lucky? Maybe, but I think this is easy to guess at. They now make their intentions and meeting notes fairly public. We're going to come upon some tricky times here shortly. With the dollar dropping, inflation over 2%, and the economy still posting good earnings and decent growth, look for rates to hold steady until the EU central bank cuts rates for 2-3 times, oil steadies at $58-60/barrel, and the deficit drops a little bit more.
(9) obey rules 1-8!
