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How You Can Skin the Wall Street Pros

I'm a voracious reader. And I'm also a relentless networker.

In this business, I have to be. I need to see and hear as much as possible in order to form the opinions, forge the recommendations and assemble the market intelligence that enables us to help you pull down big profits.

Creating Private Briefing made it even easier for me to do all that for you.

Now I have direct, daily access to six of the most impressive investment gurus you're ever going to find – folks like Keith Fitz-Gerald, a globe-trotting expert and best-selling author with decades of experience in international markets … or Peter Krauth, the natural resources expert who's so serious about his work that he lives in Canada to be close to the companies he covers … or Martin Hutchinson, who has actually been hired by countries to fix their economies.

Let me tell you a quick story that shows why this matters. And after that we'll take a look at some investing strategies we think you need to consider – especially right now, with the market in record territory.

These are strategies that will allow you to keep pursuing profits on your existing holdings, to add new positions at prices that will help you extract the maximum-possible returns, and to protect all of your holdings against a possible correction.

So let's start with my story.

Back on Jan. 30, I spotted an report with the headline: "High-Yield Bond ETF Pullback a Warning Signal for Equity Bulls?"

In the true spirit of Private Briefing, I immediately telephoned Keith to ask this question: Was it time for readers to start worrying about a correction?

Not yet, Keith said.

"Historically, BP, it's true that this has been a cause for concern," Keith said during that end-of-January briefing – which we published the very next day. "But today, with the incessant Fed meddling that we've seen, my instincts tell me that this historical linkage is busted … or at least is broken to a degree that I wouldn't put the same level of confidence in this indicator that I might have had five or 10 years ago. So my answer is that I don't believe this is an early warning signal."

The Dow Jones Industrial Average closed at 13,910 that day.

It's at 14,578 right now – meaning it has climbed an additional 5% in the two months since Keith dismissed that warning (or about half the average historical gain for an entire year). So if you listened to Keith's analysis, you padded your portfolio.

Now, however, Keith is warning that a market correction has become much more likely – not definite, mind you … just more likely.

But we can provide you with some risk-management tools that will let you stay invested and reap the added profits that will come from a continued market advance – but that will also minimize the damage should the U.S. stock market turn over.

Here are three in particular that every investor should employ.

Trailing Stops: The other day, subscriber Peter 12 (I call him that because his "screen name" on the Private Briefing site consists of 12 digits) dropped me this note: "Bill, at the end of every column, I see that you mention "trailing stops.' What are they, how do they work, and how can they help me become a better investor? Why should I use them? Forgive what's probably a pretty basic question – I'm just not hip to the financial lingo."

No apology needed, Peter.  As a guy who spent 20 years working as a financial journalist, I know as much as anyone that the only "stupid" question is the one that isn't asked. And, truth be told, this question is an excellent one to pose.

A "trailing stop" is an investment-risk-management tool – one of the very best. That's why every one of our experts advocates its use. (As Peter 12 notes, we remind readers to use it in the "Editor's Note" that follows every Private Briefing column.)

It's actually a "stop-loss" order that is typically set at some percentage below your initial purchase price. (Unless otherwise directed, Keith usually advises trailing stops be set at about 25%.) As the stock moves up, your trailing stop moves up in near lock-step.  

What's great about this is that the "stop" price – the price the stock will be sold at – is adjusted as the price fluctuates. So if the stock runs up, the trigger price moves up, too. And that means the "trailing stop" serves a dual role as both a risk-management/lost-minimization device … and as what Keith likes to refer to as a "profit-harvesting" tool.

For instance, you buy a stock at $10. You set a 25% trailing stop. It turns out the recommendation doesn't work out, and the stock falls 50%,  all the way down to $5. At $7.50, you're out. That's 25%. So you take less of a loss than the "masses," and move on to your next opportunity. (And if you observe the "position-sizing" limits we advocate, the loss to your portfolio isn't that bad. We'll address that next.)

Let's say the stock acts as expected, though, and rockets 60% – meaning it soars to $16 a share.

After that, however, let's assume the market weakens, and stocks start to fall – including yours, which is soon down to $10.96. With many individual investors, the emotional inclination is to stay invested, because you want to get back to that $16 price level and have your 60% gain be made "whole" again.

Unfortunately, the markets often don't work that way.

As Keith explains it, the "trailing stop" makes sure that you keep some of your profits. If the stock falls 25% from that $16 peak, or $4, you're out. So emotion is removed from the equation, and you keep 20% of your profit.

You may not be happy with that – until you look a few weeks later and see that the stock is now trading at $6 … meaning that had you held on, your 60% profit would've swung to a 40% loss.

And we've seen that happen plenty of times.

"Trailing stops are one of the most important tools that investors have at their disposal because they allow you to accomplish two things at once – capture profits and protect your capital from catastrophic loss," Keith said.

Position-Sizing: We often tell folks to limit their purchases of any one stock to no more than 1% to 3% of their investable assets. Doing so – especially with the higher-risk/higher-return "rocket-rider" stocks that we sometimes find – limits the damage from the losses which do occur from time to time, even with the best-researched recommendations.

Here's an illustration. Suppose we recommend a $2 biotech stock. We tell you that an FDA approval could cause the stock to double or triple (and that's just what's happened with a number of our recommendations, as longtime subscribers know). But a rejection could cause the stock to crater. In this case, we advocate a 50% trailing stop – but only if you limit your purchase to 1% of your holdings. We advocate the wider-than-usual stop because the stock is so volatile – and we don't want to see you "shaken out" by normal fluctuations.

If you observe those parameters, even a 50% loss on this one stock only amounts to a loss to your portfolio of one-half of 1% – leaving you healthy and ready to invest another day.

"One thing that a lot of retail investors don't realize is that institutions may take three, four, five or more runs at a position – before it finally pays off," Keith said. "They can do this because they limit the downside on any of the individual transactions – so that they're in on the trade when it ultimately pays off … and pays off so well that the other losses are dwarfed. Retail investors get caught up with being right. Traders just want to be profitable."

The "Free Trade:" This is one of Keith's most-important rules here at Money Map Press, and it's a doggone good one. If you make an investment and it doubles in price – meaning you have a 100% gain – then sell half and let the rest ride. By doing this, you've covered your initial investment and are now literally playing with the "house's money." You can continue to use trailing stops on this free-trade holding – or you can let it ride, Keith explained.

At the end of the day, having converted your investment into a free trade, you've really achieved the best of both worlds," he said. "That's because you've not only paid for your trade, you've also pocketed substantial gains and removed your money from the institutional steam-roller that runs over a majority of investors who don't understand the significance of actually paying for their investments."

When you invest in the stock market, you want every available advantage. Sometimes that comes from stock selection. Other times it stems from the way you've structured your portfolio.

But, as Keith tells us, "a good deal of the time it's simply from learning how to beat the Big Boys at their own game."

[Editor's Note: Unless otherwise specified, we recommend investors employ a 25% "trailing stop" on all holdings.]

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