How To Protect Your Investment Capital

What do you expect when you buy a stock? We expect the stock price to go up so that we can sell at higher price than we originally bought them and take the profits. But many times things turn out not as we planned. What happens if the stock price does not go up but instead go down? It goes down 5%, 10%, 15%...50%.... If you don't cut you losses, you will lose your hard-earned money.

You may face financial difficulty if you buy stocks on margin. This is the actual situation during the last few years when NASDAQ plunged from the peak of 5000+ points to 1000+ points. Imagine if you put your stop losses in place, normally about 10%, you are out of the wood and just lost 10% of your money.

Nobody wants to sell a stock at a loss; it is a loser feeling. I have the same feeling many years back. I bought the stock at $18.00 and you ask me to sell at $16.20, no way! Yes, this is exactly what most investor would respond.

When stock market crashes and if you don't stop loss at $16.20, you will be watching your stock plunging from $16.20 to $12.00, to $8.00, to $4.50 and 40 cents. This is why so many investors lose money, houses and cars. By applying this simple rule of cutting your losses, you can protect your capital from further shrinking.

This sounds simple but it works ALL THE TIME! Stop loss is not only a rule. It is a stock market principle. Do you know that there are only two types of investor in the market, the donor and the collector? Which type are you? Do you want to join in the collector group? If the answer is yes, don't act emotionally, and apply the stop loss rule!

It is not easy to be the collectors. Even the fund managers are not able to be collectors. Sometimes they are donors in a big way. Do you think fund managers out there really make money for you? Their job is just to beat the index. If the index drops 30% and their funds drop by 25%, then they consider themselves as heroes. For fund managers, there are many rules and regulations that restrict them from cutting losses. But as an individual investor, you can.

Stop loss is just like buying house fire insurance. You pay a small premium to protect your house (capital). You will get paid in full amount if your house is burned down (Market Crash). Similarly in stock market, you just pay small premium (10%) to protect your 90% capital. Protect your capital and you can come back any time. There are so many good stocks and so many opportunities out there.

As a successful investor, you should not have emotion with your stock. They are just business products helping you making money. Don't fall in love with them. When time comes to cut loss, just sell them off without emotion.

Many investors lose money in the market because they don't want to sell their favorite stocks. They think the stock price will bounce back eventually. If you let your stock goes down 50%, you will need the stock to climb back 100% just to breakeven. How often stocks double in price??? Yes, sometimes the stock price will come back, but most of the times the stock price never rebound. Yes, I mean never. So, why take the risk betting and hoping the stock price will come back. Just take a small loss and move on to other stocks.

David Chew is a professional marketer and has been helping others to succeed in home business since 2002. You may subscribe to his Weekly Quick-Retirement Tips at http://www.quick-retirement.com

David is also a veteran stock and option trader. He is the Author of 'Stock Market Survival Kit - The 8 Golden Rules'. Check out the website http://StockMarketSurvivalKit.com

It is important to note that every smart investor wants to minimize risk while maximizing profit potential. Yet conventional investment theory tells us that in order to increase returns, you have to increase risk.

You may be surprised to find that this conventional wisdom is not always true.

When I was a professional stock trader, I made most of my profits from appreciation in my portfolio, not in short term trading. In other words, I was a position trader. Any losses in my stock positions were taken out of my paycheck at the end of the month – in fact, I had to pay back any loss. If you are in this position, you desperately want to learn all the techniques to make large profits without risking much. I became an expert out of necessity. So while my trading account had virtually no losing months, my gains were as much as 300% per year.

In my stock picking, I first looked for stocks that were so cheap they could not go down. If they did go down, I was happy to buy more because at those prices, you could buy the whole company and sell off the assets for a profit.

From this group of “safe” stocks, you select the ones most likely to have large appreciation.

A stock is cheap in my book if it sells below the liquidation value of its assets, and most cheap if it sells anywhere near the net amount of cash it has on hand. So the first two measures of value I looked for were book value per share and cash per share.

Book value is the value of the shareholders equity carried on the books of the company. Generally, since you are buying a share of stock, you will want to know the book value per share.

The one caveat to looking at book value is that companies often have intangible assets on the books, goodwill and the like. You have to take these intangible assets with a grain of salt. The safest thing is to look for “tangible book value.”

Book value per share is often calculated for you in the various Internet financial stock search programs available.

The next indicator to look for is cash per share or working capital per share. Working capital is current assets minus current liabilities. These assets are near to cash or will generally be turned over in one year: receivables, inventory and the like.

To measure the health of working capital, divide current assets by current liabilities to get the “current ratio.” A current ratio of two to one or better usually indicates a solid company. As long as the company does not have any long term debt, or at least none coming due in the near future, the company is solvent and should be around for a while – little or no bankruptcy risk.

Next, we look for low price-earnings (P/E) ratios. In my opinion, buying high P/E stocks to chase growth companies is inviting real risk. If the company disappoints in earnings, not only will the stock drop from lower earnings, the P/E ratio will deflate as well, giving you a double hit.

OK, so you have found a company that is selling at or below book value with a current ratio better than 2:1, and a low, low P/E. It may be that the stock will not go down, but will that stock go up?

Picking growing industries and growth companies is more than I can tell you here, but there are two simple things you can look for first: (1) Is the company buying its own stock, or has it bought its own stock at about this price, and (2) are the insiders making hefty purchases of their stock?

Next, you can look at the ratio of revenues or sales to market values or the dollar amount of sales per share. Generally speaking, the company with a relatively high amount of sales per market value or sales will have more action on the upside. That company has more revenues to make profits from.

After you have narrowed the field using the above techniques, there will be no substitute for intense homework about company prospects to find which of those cheap stocks that truly give you superior returns, what I call my “Home Run Stocks.”

John Lux is a former OTC Trader and author of the book, “How to Find a Home Run Stock.” To read the book and find your own Home Run Stocks, click http://www.asklux.com/investing-books/home-run-stock.htm. Email John at john@asklux.com