pm EST, Tuesday, October 9, 2001
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SmallCap Network Members:
you for joining us and for your feedback. We appreciate
hearing from you. Our last issue offered some
general guidelines for effectively managing a
micro and small cap stock portfolio. Most of these
rules and guidelines apply across the board, whether
investing in large, mid, small, or micro cap issues.
As a result of Member feedback, please allow us
to expand on this topic for a moment. It is important
to clarify a very important fact. The same rules
apply to successfully managing an individual equity
position or an entire portfolio whether in a bull
or bear market.
When managing micro and small cap holdings, it
is sometimes more prudent to accumulate a position
over time rather than "jumping in" all at once.
(Please note we qualify this by saying "sometimes."
NOT "always.") The reason for this has more to
do with liquidity, volatility, and other risk
factors rather than anything else.
Committing 10%, 25%, or 50% of the total capital
allocated for one position is an important way
to mitigate risk. It's been often said it is not
a "stock market" but a "market of stocks." Meaning,
even in a declining market it is possible to find
stocks capable of producing positive performance.
As witnessed through recently released statistics,
money market funds are bulging with about $2.2
trillion. This is a definite positive. The current
market environment favors certain obvious groups:
defense, health care, oil, gold and utility issues
to name a few. Through several difficult weeks,
defense contractors and companies specializing
in advanced security technology have had particularly
We'd like to clarify for one Member who somehow
confused the guideline titled: "LET WINNERS
RUN" with "RIDE THEM UP AND HOLD THEM BACK DOWN."
We'll thank that Member for leading to a very
good point, however. Investors taking stock should
always answer this question before making any
investment commitment: "What is the objective
in making this investment?"
Obviously, the aggressive trader has different
objectives than the long-term investor. If the
objective is to capture a 10, 20, or 30% short-term
profit and the objective has been achieved, TAKE
THE PROFIT! If your objective is to position a
portfolio for maximum long-term success and a
newly established position is down 8%, "Murphy's
Law of Investing" says it will probably fall further
However, when building a position over time, it
is easier to live through a 10-20% decline or
more, especially if it only represents 1/4 or
1/2 of a fully invested position. Once any new
position has been established, setting a MENTAL
STOP at a reasonable level beneath the position's
cost basis is more than just a good idea.
The SmallCap Network strongly advocates the use
of MENTAL STOPS to protect profits and limit losses.
If you own micro and small cap stocks and aren't
using MENTAL STOPS, we encourage you to START
TODAY. Many investors aren't aware or don't understand
the purpose of using MENTAL STOPS. They are a
valuable "tool" in the portfolio management equation.
A MENTAL STOP is a predetermined or
"set" price that triggers a predetermined action
undertaken when trading action hits or breaches
that price point, resulting in a partial or complete
liquidation of the position.
Investors who closely monitor their portfolio
can set MENTAL STOPS based on an intra-day price
trigger or the stop can be set based on a stock's
CLOSING PRICE. For many investors that may be
easier to manage. CAUTION: Don't allow the time
between sessions to alter the predetermined course
of action. The position should be liquidated immediately
at the opening of the next trading session.
Common sense suggests if a position has performed
well and the desired performance objective has
been achieved, don't ride the position all the
way back down to the cost basis. Raise the MENTAL
STOP and protect the profit! If you are not using
MENTAL STOPS, your performance results will greatly
improve once begin using them.
MENTAL STOPS help keep winning positions from
turning into losers and losers from turning into
disasters. Keeping a written log of the MENTAL
STOPS for each position in the portfolio is recommended
for making this technique easier to employ. Just
VALUATIONS AND AN EVENT DRIVEN MARKET
We would like to offer special thanks
to Member HBIV, who wrote in regarding our comparison
between the early 60's market and today. HBIV
managed money in the early 60's and he pointed
out that valuations were lower (12-15x S&P500
earnings) in the early 60's compared with those
today (around 20x S&P 500 earnings.)
HBIV also points out correctly that over-valuation
cycles have historically been followed by cycles
of under valuation, as witnessed all too painfully
since April, 2000. However, technology advancements
have enabled companies to achieve higher growth
rates in shorter time frames over the past fifteen
This factor MAY help cushion the market from further
deterioration in the weeks and months ahead. With
that in mind, we call your attention to the two-year
chart of the NASDAQ below. The light blue line
represents the 200-day moving average of the NASDAQ
and the yellow line represents the 50-day moving
The tech heavy index is headed towards an inevitable
retest of its 200-day moving average. It also
appears likely to occur sometime within the next
several months. This promises to be a very significant
event when it happens.
We will be watching very closely to see if, as
HBIV suggests, valuations work their way back
to more historic norms or the market breaks out
and starts working higher again at that juncture.
It looked like the NASDAQ was almost ready to
attempt a retest before failing off in August.
Leading up to the events of September 11, the
market drifted towards a retest the lows before
plunging sharply after the market reopened and
the crisis unfolded. The Federal Reserve and the
Bush administration have taken dramatic steps
to improve economic conditions and the markets
have rebounded since the September 21 low.
Now that the U.S. has begun military actions,
the risk of events unknown probably sends the
market sideways for a few weeks. In the meantime,
several important reports on consumer sentiment
will be released later this week.
On Thursday, September chain store sales numbers
will be released and on Friday, September retail
sales will be released by the Commerce Department.
The University of Michigan releases October consumer
sentiment numbers on Friday.
As we've learned all too well anything can happen,
so be prepared for action.
* * * * * * * * * * * * * * * * *
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