The Weekend Edition is pulled from the daily Stansberry Digest.
My parents met in a casino in Reno, Nevada in 1970...
My mother worked as a cigarette girl. My dad spent a lot of time in Nevada. Although he ran a chain of beauty shops in the area and worked as a hairdresser, he would tell you he was first a professional gambler.
When I was a kid, this seemed to be a generous assessment of his "profession." He gambled every day – keno was his game of choice – and through the years, he had a few big winners, though he certainly gave that money back over the long run.
Having always loved numbers myself, I began to study the math of different casino games.
I always found blackjack to be the most interesting game...
What fascinates me about it is that for every hand, there is a mathematical "answer" to what you should do next...
Depending on what the dealer is showing and what cards you have, you can know exactly what to do to maximize your chances of winning the hand.
Of course, the casino holds the advantage. Even if you play perfect blackjack, the casino always has a house edge of about 0.5%.
The single most difficult psychological decision for blackjack players is what to do when you have 16 and the dealer is showing a 7 or higher.
The correct answer is that you should "hit" (ask for another card)... But if you do, you'll "bust" (get a card that pushes you over 21 and, therefore, lose) nearly 77% of the time.
It's difficult to understand why the math says you should knowingly make a bet if you know you're going to lose more than three-fourths of the time...
But the math says it's the right play, due to the high probability that the dealer is sitting on a 17 (or greater) – and therefore likely has a hand that will beat yours unless you take a chance to improve it.
This example works equally well playing at the tables in Vegas and trading stocks on Wall Street...
Sometimes, the best decision is to do something that seems like a losing trade. Perhaps it will be in the near term, but it's still the right move.
In October, I told my Empire Elite Trader readers to close out of our position in streaming company Netflix (NFLX). We bought the stock based on an extremely oversold condition, and it worked perfectly... Just 18 days later, we closed the position for an 8% gain.
The company was set to report earnings the next day. Because our original trade had nothing to do with earnings, we decided to take our profits off the table.
Following satisfactory earnings, NFLX shares skyrocketed higher in after-hours trading, at one point soaring 10%. One subscriber accused us of being "shortsighted." But did we make a huge mistake?
The next day, Netflix closed up 4%... And within a few days, it was trading 5% below where we sold. Though shares eventually turned back around and have since continued higher, the trade reiterates an important investing lesson...
If you have a plan, stick with it. You won't regret it in the long term...
It's like hitting on 16 when the dealer is showing a 7. Sometimes your plan works, and sometimes it doesn't. But if you have a plan in place – and you stick to it – you give yourself the best odds of winning.
Of course, hopefully your trades have a higher chance of working out than a hand of blackjack. But investing does include a chance of losing your money.
That's why the most important thing you can do as an investor is to be disciplined.
Whether you're gambling in Vegas or investing in the stock market, one of the first things you should do is lay out your goals. When I play blackjack, I have two goals: to enjoy myself and to try to win money.
In investing, "enjoying yourself" is a valid goal, too. Investing can be intellectually engaging. It allows you to learn about new businesses, economics, and human behavior and psychology.
The difference is, you are not at a mathematical disadvantage when you invest... if you do the work and maintain your discipline.
When I walk up to the blackjack table, I make two decisions ahead of time: how long I want to play and how much money I'm willing to gamble (and potentially lose). Then, I either lose it all (and walk away from the table) or double my money (and walk away from the table).
That's an approach that has treated me well on the blackjack tables over the last 20 years. And with a few adjustments, I've found that it works well in the stock market, too.
In blackjack and investing, you'll do much better over the long run if you plan the trade and trade the plan...
This means you must do three things...
- Never gamble (or invest) more money than you can afford to lose.
This one is self-explanatory. Whether you're gambling or investing, it's never a good idea under any circumstance to bet your mortgage or rent payment. Enough said.
- Stick to your bankroll.
Position sizing is key. In the same way you shouldn't push all of your chips in on a single hand of blackjack, you shouldn't go overboard in any one stock.
Generally, I recommend taking larger positions in bigger, more liquid companies with long operating histories. The chances that you suffer a major loss with them is much lower, which means you can bet bigger on them. Alternatively, for smaller, more volatile stocks, you should size them smaller to help mitigate your potential losses.
- Have an exit strategy.
Your "plan" can take many forms, but the easiest exit strategy in the stock market is using stop losses.
It's simple math... If you set your stop loss, say, 25% below your entry price and you're disciplined about executing it, then you'll never lose more than 25% on any single position.
You can widen or tighten your "trailing" stops depending on the particular stock and its volatility. But the percentage itself is less important than actually sticking to the plan.
A losing position can be mentally overwhelming, which can cause you to make other mistakes in your portfolio. Using the blackjack example, imagine being so preoccupied by a previous losing hand that you then fail to make the right decision in the next hand.
Staying disciplined with stop losses also protects you during a market correction or an outright bear market...
The vast majority of the time – more than 90% – the stock market goes up. Several times a year, though, the market falls in what should be considered a "healthy" balancing of the sentiment in a bull market. Sometimes, these corrections aren't just a brief balancing of sentiment, but the start of an extended downturn. This is where investors can suffer massive losses.
Stop losses kept my hedge fund afloat through the major downturns over the last 30 years – like the historic collapse of Long-Term Capital Management, the bursting of the dot-com bubble, and the 2008 to 2009 financial crisis.
That's because 99.9% of the time, the market environment is one where using trailing stops in a trading portfolio is the right move.
These three principles are key to long-term investment success. They'll make sure you plan your trade and trade your plan... and help you maximize your winners and minimize your losers.
Regards,
Enrique Abeyta
Editor's note: In a recent video, Enrique highlights how everyday investors can benefit from the approach that helped him grow his first hedge fund by 130,000%... And he even shares one of his favorite stock ideas today. You'll also learn how to get a "Charter Membership" for Enrique's unique research – which includes more than $2,200 worth of free bonuses – at 65% off the normal rate. But this offer ends on Monday. Don't delay – watch the video for more details.
