Smart Investing Daily – How to Protect Yourself From Market Sell-Offs

I went to an estate sale over the weekend and had the pleasure of meeting a seasoned art collector and dealer. Jack not only has been around the world, but has dealt with some of the wealthiest folks here and abroad selling his wonderful findings, all while gathering quite a bit of insight and opinions on everything from politics to art and even the stock market.

We got to talking about money and stocks after he asked what I did for a living. He immediately began to express his frustration with Wall Street and the current housing (lending) situation we find ourselves in. (We will save the latter for another article.)

Jack was convinced that there is a group of “evil” Wall Street folks who control stock prices and caused the great downturn we experienced in 2008. While I believe that there are people out there who are inherently bad on Wall Street and otherwise, and who did have a hand in the global financial crisis, we can’t simply blame them for everything that goes wrong with the stock market and live in fear. And beyond that, you can fight back and protect yourself!

By the way, in their newly released book, Barbarians of Wealth, my co-editor Sara Nunnally and Taipan executive publisher Sandy Franks extensively detailed some of the most reckless actions and deliberate decisions of powerful people throughout history, including those actions that nearly brought down our whole financial system… It’s one of the most interesting reads out there, and truly an eye-opener.

A Simple Plan

The fact of the matter is that many novice investors buy or sell stocks at the end of their trends, right before a sell-off. Part of the problem is that many people buy investments based on a tip from a family member or friend, a hunch they have or maybe even a news story. All these methods are OK to start with, but you should back up unqualified advice with research and some timing to prevent catastrophe. You can start by creating a checklist.

Here are four indicators for you to verify before you enter a trade (in addition to your own research):

P/E Ratio

Just two weeks ago, I cautioned readers about NFLX, not because I had done countless hours of research or had inside information, but simply because I saw the price/earnings (P/E) ratio was extremely high. Since writing that article, NFLX has dropped more than $42, a whopping 17%.

Checking the P/E ratio is simple. Go to Google Finance* and type in the ticker of the stock you wish to evaluate. For the novice, simply compare the P/E of that stock to the peers that are in the same sector (they will be listed in the middle of the page). If the P/E seems much higher, perhaps that stock is expensive, which may be warranted, but it’s certainly a caution flag. On the other hand, if the P/E is lower, the stock may seem relatively cheap; again, you may want to dig further.

This method is a quick test to see if there is a big value discrepancy between your stock and the others that are in its sector.

*The P/E usually displayed on Google Finance is based on the past year’s earnings; you can also view the “forward” earnings, which are based on analysts’ estimates.

(Investing doesn’t have to be complicated. Sign up for Smart Investing Daily and let me and my fellow editor Sara Nunnally simplify the stock market for you with our easy-to-understand investment articles.)

Moving Averages

If you are a longer-term trader, holding stocks for over three months, use the 50- and 200-day simple moving averages (SMA) to gauge trends. Generally, if I am bullish, I want the 50-day SMA to be above the 200-day SMA. The stock price should be above both! If the stock starts to dip below the 50-day SMA, and doesn’t get back above it within a couple days, there could be a change in trend coming and you should be cautious. To many traders, a weeklong dip below the 200-day SMA is a sell indicator for a stock.

This is what it looks like to have the 50-day SMA above the 200-day SMA.

View larger chart

Note the recovery back above the 50-day SMA in JJG, which Sara discussed in yesterday’s Smart Investing Daily.

Volume

Volume is the cause and price is the effect. When a stock is trending, you should have at least steady volume. If a stock is moving within a trend and the volume is decreasing dramatically, use caution, as there may be an end coming to that trend. You don’t want to be the last one in when a stock is topping out.

Also, watch for volume spikes! If the daily volume is extremely high compared to the average, you might want to check the news and make sure there isn’t a story that could make the stock overreact and then the next day come crashing back or vice versa.

Odd-Looking Charts

I realize many of you are not traders by profession and may not look at stock charts on a daily basis. But it wouldn’t hurt to pick up a book like The Complete Idiot’s Guide to Technical Analysis by Jan Arps to learn about chart basics. There are certain formations that can spell disaster for a stock and others that should at least raise the caution level if you are already in a stock.

I saw an “odd” formation last week in the oil charts. Everyone was still jumping on the long oil bandwagon, but that formation saved me from making a costly mistake.

Here at Taipan Publishing Group, many of our editors have their own ways of viewing the charts and offer detailed commentary on the formations, but it never hurts to get a basic education on some of the most common patterns, so you can maybe spot the hurricane on the horizon, before it hits your account.

Summary

Always have a plan of attack and have it written down. In the markets, ignorance can lead you to agony, not bliss…

If you don’t know something, don’t be afraid to ask and keep yourself informed with current and upcoming events. Don’t be afraid to use us as a resource — all of the experts at Taipan Publishing Group offer their own diverse commentary on all the markets!

Editor’s Note: Most people are too busy denying the facts to even touch this story. We’re likely to be called crazy for running this story. But at the risk of ridicule, we feel you need to know about what’s going on. As I said, most people wouldn’t even consider sharing this with you. Judge for yourself by following this link.

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Other Related Topics: Barbarians of Wealth , Investment Portfolio , Jared Levy , Market Analysis , Smart Investing Daily , Wall Street

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