Saturday, August 29
Before I get to the meat of today's update, I want to bring your attention to an article at Zero Hedge regarding the price of the S&P 500 as a ratio of money in the economy. Here's the link to the article.
For those of you who don't get off on all things financial-geeky, here's the gist of it:
The Federal Reserve is responsible for "...conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates,".
The S&P 500 is a proxy for the entire stock market, because it is an index composed of the 500 largest publicly traded companies. You can see the exact make-up here.
When the value of the S&P 500, (and by extension - the overall value of the stock market), is expressed in terms of the money supply, (which is controlled by the Federal Reserve), then the market has actually done nothing since the crash of 2000 and is in fact significantly lower than it was during the depths of the 2002 recession. In other words, all the extra money that the Federal Reserve has pumped into the economy has done NOTHING for real values.
On to the News Of the Week
WHAT IT IS: As I mentioned last week, the S&P 500 is currently trading at about 143 times earnings. At the height of the dot com bubble in the late 90s, the highest the S&P ever traded was 45 times earnings.
WHAT IT MEANS: Historically, the S&P trades at an average of 15 times earnings. In other words, this market is grossly overheated and a massive correction is due.
WHAT YOU CAN DO ABOUT IT: Many of you lost a lot of money in your portfolios last fall, and have watched in relief as the market has regained some of that lost ground. I want you to protect yourself this time, and not make the same mistake when the market collapses again. Here's how: You must place a "Stop Loss Order" for every stock you own. So what is a "Stop Loss Order"?
A Stop Loss is an order to sell the stocks you own IF and ONLY IF the price falls to your Stop Loss price. So for example, if you own 100 shares of FroBozz Corp, and it is currently trading at $45 a share, you might want to enter a Stop Loss order for 100 shares at $40.50, which would be 10% below the current price. If the price falls to $40.50, then your Stop Loss will be executed. If it doesn't fall that low, then you will continue to own the stock.
How do you calculate the price at which to enter your Stop Loss? That is a matter of personal preference. William O'Neill, in his classic book How to Make Money in Stocks, recommends using an 8% stop. Another way to calculate a stop amount is by looking at a chart and finding historical support levels, then placing your stop just below those levels. A more sophisticated form of stop-loss is the trailing stop. A trailing stop trails the price of the stock as the price rises, but does not move if the price of the stock falls.
Returning to our previous example of FroBozz Corp, let's again assume it is trading at $45. You could place a $4.50 Trailing Stop Order. If FroBozz rose to $50, then your Trailing Stop would rise with it, and would now be at $45.50. If the price of the stock then falls back to $45, your Trailing Stop would be executed at $45.50.
The subject of Stops is a little more complex than this, but that should give you some idea of how to protect your profits rather than take a huge loss. Make no mistake - a massive correction is coming in this market. Don't get caught this time.
Monday morning - call your broker - place Stop Loss orders. Don't let him talk you out of it.
Till next time.
Posted by JackAz at 4:54 PM