Dilute Market Risk with Proven Strategy

April 15, 2014, 11:40 am ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

In order to now be confused by the Stock Market we must start with removing the dependence we have on the stock market.  We can do that by empowering our competitive advantages as individual investors.  We do not need to focus on interest rates, stock market levels, economic conditions, or any other of the vast number of variables to do this either.  I will explain what I mean here.

Before I begin, this approach is for individual investors, not multibillion dollar institutions.  Individual investors have a distinct competitive advantage over these large firms because individual investors are much more nimble.  The institutional firms that actually control most of the money individual investors have also have a much more difficult time navigating markets when the going gets tough.  To put that into simple terms, an order to sell $1 billion worth of a security is far more difficult to fill than an order to buy or sell $100,000 worth of that stock.

Therefore, proactive strategies that are nimble and that do not rely on the stock market to increase for people to make money are also often targeted to individual investors who have the competitive advantage of being nimble.  The trouble is, individual investors either do not have the time or make excuses that prevent them from enabling their competitive advantage.

Either way, individual investors need support to enable their competitive advantage, but the good news is most online brokerage firms now provide the tools necessary to engage some proactive strategies at least.  The requirements for those are that they are based on conditional orders and most online brokerage firms already allow individual investors to place conditional orders.  Therefore, without sacrificing time or lifestyle, individual investors who think they cannot empower their competitive advantage, actually can.

Here's a good example:

The basis for this example comes from the Stock of the Week strategy I offer on stock traders daily.  The performance of this strategy proves that proactive strategies can work in any market, but the basis for the strategy is also something that individual investors can empower for themselves.

The concept is simple.  Select one stock to trade every week, and end every week in cash.  On the weekend, determine the stock for the week ahead using first an evaluation of the stock market itself, and then find a large cap, highly liquid stock that is not scheduled to release earnings or any other important news in the week ahead, one that has also been trading with the market recently, and trade that stock in line with the stock market according to a correlated trading plan.

Ending every week in cash is extremely important because it allows us to approach the upcoming week objectively.  We're not holding on to positions that are under water, we're not holding onto positions that are well in the money, and we have no ties to the market one way or the other when we end every week in cash.  Not only does that allow us to approach the next week objectively, but it also allows us to be more present with friends and family without the burden of the stock market lingering over our head all weekend.  Ending every week in cash is extremely valuable, more valuable than people think.

In addition, focusing on the stock market is also extremely important.  Evaluating the direction of the stock market is much easier than evaluating individual stocks almost always, because there are far fewer variables that go into an evaluation of stock markets, so basing the decision to buy a stock or short a stock during the week ahead on an initial evaluation of the stock market also increases the probability of being on the right side of the curve.

Of course, stop losses also need to play a role, and we must only enter the position when trading signals occur, but that is where the conditional orders that exist currently at most online brokerage firms come into play.  After we determine where that proper entry level is, we can place the conditional order to execute while we work, play golf, read the paper, or do anything else in line with our current lifestyle.

In essence, individual investors can accomplish the goal of empowering their competitive advantage to take advantage of markets that move in either direction, whether that be straight up like we saw in 2013, sideways like we have seen so far this year, and even in extreme down years like we saw in 2008. 

The beauty of this competitive advantage is that if the stock market does fall hard again, which I believe it can, individual investors who engage in proactive strategies like the Stock of the Week strategy we have been using since December, 2007, are also capable of beating the market handily over time.  Since December, 2007, the Stock of the Week strategy is up over 250% while the S&P 500 is up only 28%.

Proactive strategies work, but individual investors need support, and with the ability to initiate conditional orders individual investors absolutely have the tools at their disposal already to empower their competitive advantage and beat the institutional investors who otherwise control this market.

I will conclude with this additional word of advice.  Individual investors often are tempted to engage in positions in very high Beta stocks like Plug Power (NASDAQ:PLUG) or Facebook (NASDAQ:FB), but when you engage a strategy like this you can achieve superior results with integrated risk controls by using large cap stocks that might otherwise seem boring.  Instead of high beta names, we have used stocks like Caterpillar (NYSE:CAT) and Dow Chemical (NYSE:DOW) in recent weeks.  The concept is slow and steady wins the race, and we don't need to add risk to significantly outperform.

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