Their Own Worst Enemy

January 25, 2007
By seadmin

If you’ve been an Alert reader for even a short period of time you probably already know my stance on protecting your assets from the destructive powers of a market downturn. But something as absolutely essential as the need to safeguard your wealth never suffers from reiteration, so I present to you two prime examples of why you must always be vigilant toward the very real possibility that any investment can turn against you.

First, let me say that I think complacency in all of its forms can be an investor’s own worst enemy. Why do I say this? Well, I’ve been in this business too long and seen too many people embrace the notion that things will continue to go up, up, up ad infinitum. Hey, does anyone still remember the tech wreck of the 2000-2002 period? I should hope so, since the big market drop took place just a few short years ago. Unfortunately, when it comes to the markets, many investors suffer from a form of financial forgetfulness. Take a look at the following two charts:

Both of these stocks — Apple (AAPL) and Google (GOOG) — have enjoyed a tremendous move higher since the midway point of 2006. And, each of these tech bellwethers has seen particularly strong upside momentum since late-October 2006. But as the song says, what goes up must come down, and that is what we are beginning to see in both of these NASDAQ leaders. When you start to see the bull bellwethers break down, watch out for more stocks to follow.

Look at the blue line in these precedingcharts. This line is a technical indicator known as the 50-day moving average. I love this short-term measure of a stock’s price movement because it gives investors a good sense of the near-term trends in place. As you can see, both Apple and Google now have fallen below their respective 50-day moving averages.

What often happens with stocks that have been on a sizeable run is that they will retreat below their 50-day moving average. This retreat often is the prelude to more significant selling in the stock. The next benchmark to keep an eye on is the 200-day moving average. AAPL and GOOG each still are firmly above their longer-term moving average. But as we’ve seen in the past, these high-flying tech bellwethers are capable of very rapid descents.

Whenever I see a stock or a sector break below its 50-day moving average, I take that signal as a yellow caution flag telling me that there’s a potential hazard ahead. I know that if I hold that investment, I might have to slow down to a safe speed up ahead. Slowing down to a safe speed with your investments means not committing any more money to weak positions and it also means that you need to start thinking about when you might sell that position.

If you currently hold Apple, Google or any other security that is falling below its 50-day moving average, you had better know it. You also always should have a stop-loss in place, i.e., a preset point in which you will sell that security. Set the stop-loss before you even enter that position. If you don’t currently have a stop-loss in place, I implore you to revisit your holdings and to determine for yourself how much you are willing to lose if that investment turns against you.

Setting a stop-loss on all of your holdings may seem like a common sense principal, but the reality is that most investors simple do not employ this pain-saving strategy. Don’t suffer from financial forgetfulness. Do yourself a favor and protect yourself against the very real possibility of a sharp market downturn. I guarantee your money will reward you if you do so.

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