When I developed the content for my first book (due out soon!), U.S. and global stock markets were decidedly bullish.
It was late 2017 and early 2018. And everything was going up.
Capital preservation was probably the last thing on anyone’s mind at the time.
Everyone was focused on making as much money as possible. Risk management was an afterthought, if even that.
To be frank, I felt a little lame to be talking about capital preservation, let alone sharing a simple strategy that merely moves you to cash when stock prices start to fall.
How sexy is that?
I get it… nothing is more fun than playing bitcoin and pot stocks on their way up.
But if you’ve actually been in the markets for a full cycle – let’s say, since the mid-2000s – you should know that it’s arguably more important what you do when markets are on their way down.
The logic here is pretty simple: If you don’t survive a bear market, you’ve got nothing to invest when the next bull rolls around.
Even if you don’t lose it all, recovering from a 20% drawdown is exponentially easier than from a 50% drawdown.
That’s why capital preservation is so important.
And that’s why – despite feeling a bit lame about it – I made my simple capital preservation strategy a key component of my new book.
The strategy couldn’t be simpler.
First, we use a simple indicator to determine a “line in the sand” for any given investment – whether it be a stock, a sector ETF, or anything else.
And then we follow two simple rules:
Rule No.1: Consider buying it… if it’s above that line in the sand.
Rule No.2: Sell (or avoid) it… if it’s below the line in the sand.
Again, so simple it feels lame.
But here’s the thing… it works!
It’s worked for centuries. And I’m confident it will work for centuries more.
Logically, the only way to prevent a large loss is to proactively take the loss when it’s small.
We never know the answer to, “How low can it go?”
“Still lower,” is always on the table.
You can actually see this in action when you look at how markets fell into a downward spiral recently.
Take a look at this chart…
This chart tracks the major U.S. industry ETFs… oil & gas equipment (XES)… semi-conductors (XSD)… real estate (IYR)… etc.
The grey bars show how far each industry ETF was above or below its line in the sand, as of November 28, 2018… just before stocks were hit with the worst December in history.
Note that almost all of them were in negative territory – meaning the ETFs were already mildly (in most cases) below their lines in the sand.
And thus, my simple capital preservation strategy called for avoiding them!
Now, take a look at the red bars, which show the positioning of these industry ETFs as of January 2, 2019.
Which bars are more negative?
The reds bars, of course.
And what does that mean?
It means that things got worse between November 28 and January 2.
Now, that may seem like a rudimentary analysis of the past – a la, “So what?!”
But think about the effect that downward spiral had on your portfolio!
Well, I should say… if you were stubbornly holding long stock positions through the sell-off.
Clearly, anyone who did not sell their long positions in these markets when they initially fell below their lines in the sand… went on to suffer larger losses.
See how that works?
Smaller losses can turn into larger losses quickly. It’s a slippery slope.
And that’s why you have to draw the line somewhere… and commit to preserving capital when it’s crossed!
Who Feels Foolish Now?
It’s one thing to feel lame when you’re doing something prudent, while others are enjoying the party.
It’s another thing to feel foolish when you’ve been totally reckless at the party and made to clean up an awful mess.
Personally, I guess I’d rather feel lame than foolish.
And now that the markets have rolled over… I’m certainly happy with my decision to trumpet capital preservation well before the party’s end.
Mind you, I’m not in this business to generate 2-4% returns per year. Nor to simply preserve capital.
I love making big profits. And my Cycle 9 Alert service’s six-year track record is a testament to just how much money you can make with the right strategy.
But even there, I spend more time talking about risk management than I do about return potential.
I’ve learned that if you manage risk prudently and stay in the game… the profits take care of themselves.
That’s what capital preservation is all about!