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The Most Important Investment Principle of All

By Porter Stansberry
Friday, October 6, 2006

What I’m going to show you in today’s essay is, I believe, the most important investment principle you’ll ever learn.

If you follow it, as I do with my own money, you will never again have to worry about losing lots of money on any single investment. You will always know when to sell. And you will know how much money you should be investing in the first place.

For many years, I have maintained that 90% of the profits I make come from these “money managing” strategies. Most people think that because I’m a stock picker, my market-beating results stem from fundamental research and the advantage this knowledge gives me.

It’s true: Knowing a lot about a group of stocks helps you find the right ones to invest in, but this will only contribute about 10% of your gains over time. Most of the gains in stocks come from capturing swings in market sentiment.

I’ve found these swings to be, in large measure, impossible to predict. Instead, by using a simple, but reliable, strategy that I outline below, I have found I’m able to profit from the market’s upswings while strictly limiting my downside exposure.

This strategy is actually a two-step process of investing that I follow with every stock, bond, or currency.

Step #1: Letting your winners run and cutting your losses short

The first and most important principle of speculation is to let your winners run and cut your losses short. And even though the principle is well known, almost no one actually uses it. It’s just too hard emotionally.

When you’ve got profits on the table, every urge tells you “take ’em.” When you’ve got big, ugly losses staring back at you from your account ledger, every emotion says, “hold on – they aren’t losses until you take them.”

Don’t do it. Instead, cut your losers early and often. Remember that you have to have capital to make more money. Nothing sets you back like a large loss. Take many small losses and no big ones and you’ll die a rich man. You can read exactly how to cut your losses with “trailing stops” here.

Step #2: How much to invest in any single investment

The second principle that applies to every investment has to do with diversified money management.

It doesn’t matter what you’re trading, or investing in. You shouldn’t put too many eggs in any one basket.

As a rule, I never put more than 5% of my total portfolio in any single investment idea.

The whole purpose of using a trailing stop is to prevent what I call a catastrophic loss. A catastrophic loss occurs when any single position in your investment portfolio experiences losses large enough to wipe out your other gains and/or jeopardize your livelihood.

One of the biggest differences between professional investors and amateur investors is the size of their positions relative to their total portfolio. Professionals consider a 2%-3% position enormous. Having 5% of your money in any one position is considered “gun slinging” by most professionals.

Meanwhile, at conferences, when I tell investors they should never allocate more than 4% of their portfolio to any stock initially, people look at me as if I’m nuts.

In fact, I would bet that 99 out of 100 individual investors wouldn’t even know how much money they can afford to invest in a given stock, limiting the position to only 4% of their portfolio. Instead, almost all individual investors measure their position sizes in terms of shares, typically round numbers, i.e. “I own 50 shares.”

Think like a pro – think about your positions as a percentage of your portfolio, not as a number of shares. Know the stop loss points of all your positions, at all times.

This doesn’t mean you have to check the stock tables every day.

Follow this two-step principle – by cutting your losing positions, and by minimizing your positions to no more than 4% of your overall portfolio - and I promise you, you’ll see better investment results, immediately.

Good investing,

Porter Stansberry

Market Notes


Six months ago, I went to Miami and posed as a condo buyer. I suspected the condo market was in big trouble, but I wanted to see the evidence for myself.

My suspicions were correct. I found plans for thousands of new condos, yet I couldn’t see any buyers. My conclusion at the time: A crash in South Florida condo prices. To bet on this idea, we told readers to short the stock of WCI Communities. 

Yesterday, WCI dropped a bomb on Wall Street, saying tower orders had declined by 80% this quarter. One analyst said, “80 percent lower orders implies that tower orders were down to about five units.”

WCI’s stock price has fallen from $28 when I went there to $16 today - a loss of 43%.

But here’s the best part. For six months - while WCI’s stock price formed a crater - Wall Street sat on its hands and said nothing. This week, an analyst at investment banking giant UBS Warburg finally came clean and downgraded her recommendation from “neutral” to “reduce.” It only took them six months to catch on.

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