Upside versus Downside

Stocks that appear to be on sale may not be worth it. I usually won't buy a stock unless I believe I can make around 100% or more for my money. The downside risk needs to be negligible also. The fundamentals of the stock and the macro view of the world need to be examined before buying a stock regardless of whether the chart looks good or not. It is not worth it to gamble on buying a stock with a possible 20-30% upside versus a downside risk of that same amount.

A recent example of this is GMCR, Green Mountain Coffee Roasters. They sell the Keurig single cup coffee makers, and I love the one that I own. I also enjoy the single cup serving K-cups of coffee that GMCR sells. I believe the company has great products, and they will continue to grow.

However, when it comes to investing, GMCR may not be the best choice. In November of 2011, the stock price had dropped to the mid 60s from a high of over $100 per share. The chart made it appear that GMCR had formed a bottom in the mid 60s, but "the devil was in the details." It still had considerable short interest against it, and when it missed its earnings for the quarter narrowly, the stock sold off in an avalanche and dropped 38% to $42 per share. This was a costly loss of capital for anyone who had just bought the stock in hoping that it would go back to $100 per share. At $42 per share, the stock's PE was still high at 32, and it was a lot higher at $67. At its high around $108, GMCR had a PE of around 80.

So, GMCR had about as much downside risk in the mid 60s as it had upside potential. No one can deny the company's growth, but investing must be done carefully to avoid large losses. Bad things can happen as much or more than good events. Unless the downside risk of a stock of almost nothing, and the upside is fairly certain to be around 100%, it is not worth investing your money.

Fixed Asset Allocation

In today's turbulent market, it is necessary for an investor to have a good plan to prevent a possible large financial loss in stocks. One way to do this is to allocate one third of your portfolio to shorting stocks, one third for long stocks, and one third for dividend stocks or bond ETFs. For example, if you have $9,000 to invest, $3,000 would be allocated to each group.

It will also be important to keep the gains or losses inside each respective group in your portfolio. For example, if you own TVIX, the double volatility index ETF, as a stock for essentially shorting the market, and the initial $3,000 investment gains another $3,000, the $6,000 stays in the shorting group. When TVIX is high, you could sell it and buy it back again whenever it hits a low point. In this way, you could eventually make a million dollars in the shorting group, and it would not matter then if your long stocks and dividend stocks all went to zero.

This plan will protect you from losing all of your money because the stock market cannot destroy a person in all three of these directions if you are buying and selling at reasonable levels. For example, I know a man at work who bought TVIX in the first half of 2011 for somewhere in the $20 range. Then, when the stock market fell apart in August and September of 2011 due to Congress failing on budget issues and due to European financial problems, TVIX went as high as $100 per share. My friend sold TVIX at $68 after his initial money tripled since the price increased over three times. He made around $20,000 profit in just a few months with a modest investment of around $10,000, and he closed his position with $30,000.

This situation will also be highly predictable for years to come. The world will be wrestling with financial problems until the end of time, and money can be made in the stock market simply by being in the right stocks at the right time. For example, if you are patient with TVIX, you can probably make 200% profit per year just like my friend did. The market volatility will only subside intermittently because the world's problems are too great. When TVIX is low, you can buy it with your allotment of shorting funds and sell it when you are up 50% or more. Every few months, this pattern can be repeated.

For example, if you make 200% on your initial investment of $3,000 on TVIX during the first year, you will have $9,000 in this part of your portfolio. In the second year, the $9,000 can be turned into $27,000 on the short side of the market while it does not matter what the rest of your portfolio is doing. You must maintain a separation of your assets because if one group fails, another one will succeed. Then, in the third year of trading TVIX, your $27,000 could make 200% more, and you will have $81,000. When this money is doubled twice in the fourth year, then you will leave the year with $243,000 in your account all made on the short side of the stock market.

So, the way to survive in a dangerous investing world is to divide up your assets and keep them separated from each other. There will always be a temptation to put all of your money on the long side or all short or all on dividends. Just do all three, and you will most likely have overall big gains in the stock market rather than painful losses.

Insider Buying

One of the most certain signs that a particular stock or the stock market will rise is the amount of insider buying. Hundreds of insiders have been buying stock in their companies during the past few weeks. I know we still have negatives with Greece and other European countries as well as our own Congress, but it looks like we may still have a year-end rally for stocks.

One of the best places on the internet to look for insider buying is Filing4.com. They have daily listings of insider buying as well as records going back two weeks. In addition to great information, it is free. They will also send you a daily email Monday through Friday showing the insider buys of each day. You may also discover new worthwhile companies that are not yet on Wall Street's radar. So, Filing4.com is a great place for staying in touch with possible future movement of a particular stock or the stock market in general.