Trading Rules

by Dr Invest

Sections:

1. General Stock Trading Rules
2. Long-Term ETF Trading Rules
3. Turtle Trading Rules

General Stock Trading Rules

Richard Rhodes passes along these “ridiculously simple” trading rules, given to him by “a great trader some 15 years ago.”

Follow these rules, breaking them infrequently, and you will make money year in and year out.
The rules are simple. Sticking to them is what’s difficult.

“Old Rules…but Very Good Rules”

1. The first and most important rule is – in bull markets, one is supposed to be long. This may sound obvious, but how many of us have sold the first rally in every bull market, saying that the market has moved too far, too fast. I have before, and I suspect I’ll do it again at some point in the future. Thus, we’ve not enjoyed the profits that should have accrued to us for our initial bullish outlook, but have actually lost money while being short. In a bull market, one can only be long or on the sidelines. Remember, not having a position is a position.
2. Buy that which is showing strength – sell that which is showing weakness. The public continues to buy when prices have fallen. The professional buys because prices have rallied. This difference may not sound logical, but buying strength works. The rule of survival is not to “buy low, sell high”, but to “buy higher and sell higher”. Furthermore, when comparing various stocks within a group, buy only the strongest and sell the weakest.
3. When putting on a trade, enter it as if it has the potential to be the biggest trade of the year. Don’t enter a trade until it has been well thought out, a campaign has been devised for adding to the trade, and contingency plans set for exiting the trade.
4. On minor corrections against the major trend, add to trades. In bull markets, add to the trade on minor corrections back into support levels. In bear markets, add on corrections into resistance. Use the 33-50% corrections level of the previous movement or the proper moving average as a first point in which to add.
5. Be patient. If a trade is missed, wait for a correction to occur before putting the trade on.
6. Be patient. Once a trade is put on, allow it time to develop and give it time to create the profits you expected.
7. Be patient. The old adage that “you never go broke taking a profit” is maybe the most worthless piece of advice ever given. Taking small profits is the surest way to ultimate loss I can think of, for small profits are never allowed to develop into enormous profits. The real money in trading is made from the one, two or three large trades that develop each year. You must develop the ability to patiently stay with winning trades to allow them to develop into that sort of trade.
8. Be patient. Once a trade is put on, give it time to work; give it time to insulate itself from random noise; give it time for others to see the merit of what you saw earlier than they.
9. Be impatient. As always, small loses and quick losses are the best losses. It is not the loss of money that is important. Rather, it is the mental capital that is used up when you sit with a losing trade that is important.
10. Never, ever under any condition, add to a losing trade, or “average” into a position. If you are buying, then each new buy price must be higher than the previous buy price. If you are selling, then each new selling price must be lower. This rule is to be adhered to without question.
11. Do more of what is working for you, and less of what’s not. Each day, look at the various positions you are holding, and try to add to the trade that has the most profit while subtracting from that trade that is either unprofitable or is showing the smallest profit. This is the basis of the old adage, “let your profits run.”
12. Don’t trade until the technicals and the fundamentals both agree. This rule makes pure technicians cringe. I don’t care! I will not trade until I am sure that the simple technical rules I follow, and my fundamental analysis, are running in tandem. Then I can act with authority, and with certainty, and patiently sit tight.
13. When sharp losses in equity are experienced, take time off. Close all trades and stop trading for several days. The mind can play games with itself following sharp, quick losses. The urge “to get the money back” is extreme, and should not be given in to.
14. When trading well, trade somewhat larger. We all experience those incredible periods of time when all of our trades are profitable. When that happens, trade aggressively and trade larger. We must make our proverbial “hay” when the sun does shine.
15. When adding to a trade, add only 1/4 to 1/2 as much as currently held. That is, if you are holding 400 shares of a stock, at the next point at which to add, add no more than 100 or 200 shares. That moves the average price of your holdings less than half of the distance moved, thus allowing you to sit through 50% corrections without touching your average price.
16. Think like a guerrilla warrior. We wish to fight on the side of the market that is winning, not wasting our time and capital on futile efforts to gain fame by buying the lows or selling the highs of some market movement. Our duty is to earn profits by fighting alongside the winning forces. If neither side is winning, then we don’t need to fight at all.
17. Markets form their tops in violence; markets form their lows in quiet conditions.
18. The final 10% of the time of a bull run will usually encompass 50% or more of the price movement. Thus, the first 50% of the price movement will take 90% of the time and will require the most backing and filling and will be far more difficult to trade than the last 50%.

There is no “genius” in these rules. They are common sense and nothing else, but as Voltaire said, “Common sense is uncommon.” Trading is a common-sense business. When we trade contrary to common sense, we will lose. Perhaps not always, but enormously and eventually. Trade simply. Avoid complex methodologies concerning obscure technical systems and trade according to the major trends only.

Long-Term ETF Trading Rules - Ivy League Portfolio

Using these ideas, you’ll be able to set up your base portfolio and learn a easy, once-a-month trading discipline that has averaged over 10% per year and has never had a calendar year loss larger than 1% since 1973! (Past performance is not necessarily an indicator of future performance; future performance cannot be guaranteed; your investments may lose value following this model.)

From your own home computer, with just a few minutes a month, you can take control of your investments, enjoy the success and confidence of a proven trading discipline, and out-perform the vast majority of professional investment managers!

There are two parts to this system:

• The base portfolio. There are just 5 investments that you will buy and/or sell when the monitoring system gives you the signals.
• The monitoring and trading system. This is the system you look at once a month that tells you exactly when it is time to buy and/or sell the 5 investments of the base portfolio.

This article shows you exactly what you need to do to stop worrying about your portfolio and follow the Ivy League Portfolio strategy. It tells you exactly when to get in the market to get on board, and when to get out of the market to avoid horrible losses!

THIS IS A DISCLAIMER: Always keep in mind that past performance is no indicator of future performance. No guarantees of future performance are offered, and your investments using this strategy may lose value or become worthless. This document is provided for educational and informational purposes only, and does not constitute investment, legal, or tax advice. This investment strategy is not tailored for any specific investor and may not be suitable for you. By using this investment technique, you agree that you alone are responsible for your investment holdings and your trades.

What Should I Expect from Using this Method?

This investment method isn’t designed to provide you the maximum possible investment returns each year. If you like to swing for the bleachers with your portfolio year after year, then this strategy is probably not for you.

If, on the other hand, you are interested in a dependable long-term investment strategy that takes only minutes every month but has a history of average annual returns over 10% without a lot of risk to the downside, then you are in the right place!

This strategy is designed specifically to keep you out of the worst trouble when the market is headed south, and to provide a solid average return over the long run.

The chart below shows the historical returns of the Pro-Folio method since 1973, compared to the exact same portfolio purchased in 1973 and never sold (“Buy and Hold”). As you can see, Ivy League Portfolio and Buy-n-Hold performed roughly equally until the Tech Crash in 2000 and the Financial Crisis in 2008. It seems that Pro-Folio kept folks out of trouble during these difficult periods in the markets.

As shown in the Appendix, this strategy provided an annual average return of 11.27% yearly during the period 1973 to 2008, before fees. That is 1.5% higher every year than a similar portfolio that simply bought the same investments in 1973 and held them to the end of 2008.

CAUTION You must subtract the fund fees embedded in the investments, as well as the costs of buying and selling, from these returns to arrive at the actual returns that you would have experienced as an investor during this period. The investor performance difference will be slightly smaller due to the buying and selling costs of the Pro-Folio model that are not incurred in the Buy & Hold portfolio. Both portfolios would incur the fees embedded in the investments.

You should note, again shown in the Appendix, that Pro-Folio out-performed a Buy & Hold strategy in only 17 of 36 years in a study that examined returns from 1973 through 2008 (Pro-Folio under-performed in 19 years). However, on an average return basis over those same years, the Pro-Folio method averaged 1.5% better returns year after year as noted above. So what we are saying is, you should expect this method to outperform a Buy & Hold strategy only about half the time - but that half of the time is likely to overcompensate for the other half of the time when Pro-Folio lags behind.

You should take another look at the Appendix. You’ll see that the Buy & Hold portfolio had 6 years of negative returns out of 36. The Pro-Folio strategy had only one year of negative returns in all 36.

CAUTION As you know, past performance is not necessarily an indicator of future performance, and we cannot guarantee your particular performance or that you won’t lose money using this method.

The key to remember is, when the market crashes like it did in 2008, the Pro-Folio strategy is likely to get you out of the market with smaller losses than the Buy & Hold strategy, and get you back in at a reasonable point when the market meltdown seems to be over.

What Exactly is the Difference Between Buy & Hold and Pro-Folio?

The Buy & Hold portfolio is a sample portfolio that bought the same investments as the Pro-Folio method in 1973, and then just held onto them until today. The Buy & Hold method never sells off to get out of the market at any point.

In contrast, the Pro-Folio method bought the same investments in 1973 and then used the method described in this booklet to sell off (and buy again later when indicated) each of the 5 investments in the base portfolio. The underlying idea is to get out of the market when it looses upward momentum, and get back in when momentum has returned. The timing of the buy and sell activities is based on a simple mathematical approach, so it doesn’t require any personal opinion to decide when to buy or sell. You just follow the monitoring system described here.

What is the Base Portfolio?

First, if you have little or no financial knowledge, we’ll provide a brief lesson in how people talk about investments: Our portfolio consists of 5 different investments, also called securities. A share is one unit of a security. Taken together, all the shares of a particular investment that you own are called a position. Let us explain:

You can think of an investment like a 12-pack of cola. One can of cola is like one share of a particular investment. The whole 12-pack (or whatever portion of it is left in your fridge) is your position in cola. You might also have a position in gingerale, maybe consisting of 3 cans (or shares) of that beverage.

A 3- to 5-character abbreviation called a ticker symbol or stock symbol is the most commonly used way to refer to investments and distinguish different investments from each other. Continuing with our example, maybe COL is the symbol for cola, and GING might be the symbol for ginger ale. No two different investments will have the same symbol. The symbol is the name that you can use to look up your investments on any investment information system, such as Yahoo! Finance on the Internet. The following table lists the ticker symbol for each of our 5 securities and briefly describes them:

With the exception of EFA and GSC, all of these investments are U.S. companies or U.S. government bonds.

Why do we Use These Investments?

A good, diversified portfolio consists of different investments whose prices don’t always move in the same direction in response to market conditions. Using 5 different types of investments with different price movement patterns actually smooths out the overall performance of the combined portfolio.

As a result, the swings in the overall portfolio value are less extreme than they would be if the portfolio consisted of investments whose prices responded in very similar ways to changing market conditions. When investments in a portfolio respond differently to market conditions, they are said to have a low correlation. When two investments perform similarly under similar market conditions, they are said to have a high correlation.

These 5 investments have been shown to have relatively low correlations to one another, meaning that they tend to vary in price in different ways at different times. So, on the whole, we end up with a smoother, less “roller-coaster” portfolio performance.

Why Should we Buy and Sell the Investments?

The Journal of Wealth Management published a research study written by Mebane T. Faber of Cambria Investments, analyzing the performance of this technique over the period 1973-2008. (Note: this is the Ivy League Portfolio) See Faber's book with the same name. The study determined that the trading (buying and selling) method detailed in this booklet had three major advantages, when compared to a portfolio that simply bought the same 5 investments and never sold them:

􀂃 It increased portfolio returns on average by 1.5% per year over the time period 1973-2008.

􀂃 It decreased the rollercoaster-like nature of those returns, cutting volatility (sharp ups and downs) by 1/3.

􀂃 It reduced the number of years in which losses occurred from 6, to just 1!

When you compound 1.5% improved annual performance over 36 years, you end up with a portfolio worth 70% more than a similar buy-and-hold portfolio with no trading model used! In other words, if your friend had used the buy-and-hold approach to reach $1,000,000 today after 36 years, your portfolio would have reached $1,700,000 in the same time frame using this trading method (before commissions or fees are deducted).

That’s why we buy and sell these investments!

If you like, you can visit the web site below to download Faber’s academic research paper that backs up this method:

􀃆 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=962461

How Soon Can I Start?

You can start today! Turn the page and take your first step on the road to financial success through independent investing.

Step 1: Get an Investment Account

First, you need to have an investment account in which you have full control of the investments, such as an Individual Retirement Account (IRA) or a regular taxable account with a broker. You may be able to use this trading strategy in a 401(k), 403(b), or similar account with different investments, but you may not have investment choices in your retirement plan that correspond to the ones used in this model.

CAUTION While it is our opinion that this trading model is likely to work well on a wide range of  securities, we do not have a research study proving its past results on any portfolio except the one described here. In other words, if you go off the reservation, you’re on your own!

Working with a Discount Investment Firm

Since you’re DIY (Doing It Yourself), there’s no reason to open an account at an expensive full-service brokerage firm (Bank of America, Morgan Stanley, RBC, UBS, etc). At a full-service firm, part of what your high commissions pay for is the advice of the broker or financial advisor. With this system, you won’t be using that advice.

Instead, open an account with a discount broker. All of the following have been around for a long time, are well-respected, and will save you piles of money on your trades:

• OptionsHouse – www.optionshouse.com (my favorite)
• E-Trade – http://www.etrade.com
• Fidelity – http://www.fidelity.com
• Scottrade – http://www.scottrade.com
• TD Ameritrade – http://www.tdameritrade.com (TD Amer. Allows free EFT trading, see Dr Invest ETFs)
• Charles Schwab – http://www.schwab.com

You can open an account online with most or all of these companies. If you need help opening an investment account with any of these firms, just give them a call on their customer service line. They will be more than happy to help you open the account.

How Much Money do I Need?

Really the only concern in deciding the minimum amount of money you have to deposit in the investment account, is whether the cost of the trades will eat away at your investment faster than it can grow. If you’re going to pay $9 to $20 per trade, then you could start with as little as $2,000 for your whole portfolio, and be fairly certain you’re not going to lose all your money from trading fees. Less than that, and you may be better off saving for a few more months and trying to come up with at least that amount.

The customer service folks at your discount broker can help you with everything you need to transfer or deposit funds into your account.

What About Taxes?

You will want to check with your tax advisor for your particular situation. In general, if you are following this model in a tax-deferred IRA account, then you should not incur any additional taxation by selling all your existing investments. ie: moving a ROTH IRA to a ROTH IRA.

If you plan to use this model in a taxable account, then be aware that you may be liable for capital gains or other taxes when you sell your existing investments. You may want to have a drink or two before you push the sell button. Although one option is to TRANSFER your stocks or bonds to a new account, thus, you did not SELL the stocks and there is no tax liability.

In addition, each time you sell an investment, you may create a taxable event. The gains from sales where the security was held less than a year may be taxable at your short term rate, while gains from sales held longer than a year generally are taxable at your capital gains rate. Be sure to consult your tax advisor if you have one, since we do not offer tax or legal advice.

Step 2: Set Up Your Portfolio

Monitoring System

Except for having an investment account and putting money in it, there is nothing more important than setting up your system for monitoring the prices of your investments. This system will tell you when to sell your investments early on in a total meltdown! And it will tell you when it is relatively safe to get back in!

This section shows you how to set up price charts that will show you buy and sell signals for your investments. If you follow the signals exactly – every time – then you are following this model correctly. If you ever think that “you know better” and you decide not to follow the signals, then you need to stop doing it yourself and get a full-service account with an advisor who will follow the model for you! Trying to do a “manual override” on this system will likely backfire on you. Do it at your own risk.

HINT Don’t be stupid! Follow the model. Someone smarter than us (and you) invented it and did the hard work to prove that it works.

You may want to set up this monitoring system inside your online trading account (Etrade, TD Ameritrade, etc). Since we don’t know which trading account you will use, the example we’ll provide here is one you can use with any of the online brokerages. We’ll show you how to set it up on the Internet using Yahoo! Finance. You can borrow from these instructions to work out how to set up the system in your online brokerage account if you choose.

Here are the steps:

Create Your Yahoo! Account

On your computer, use your web browser to view the Yahoo! Finance web site on the Internet:

http://www.yahoo.com/finance

If you don’t have a Yahoo! user account, then you need to click the Sign Up button shown here, to create a new account:

In the screen that appears next, fill out the personal information and follow the instructions provided. After your account is created, be sure to sign in to your new account! Then go to the next step.

Create a Portfolio

In your Internet browser, be sure you are signed into your Yahoo! account, and you are viewing Yahoo! Finance. (http://finance.yahoo.com). Then, move the mouse pointer over the tab labeled MY PORTFOLIOS and then click on New Portfolio, as shown below:

In the next screen, choose Track a symbol watchlist as shown here:

Add your Investments in the Portfolio

In the screen that comes up next, type in a name for your portfolio (shown) and then enter the 5 investments we use in this model, as shown:

After you have typed in the investments, click the Finished button in the upper-right-hand corner as shown here:

After you click Finished, the following portfolio outline appears:

Good work! You’ve created your portfolio and populated it with the investments from the model. You’ll be able to access this portfolio any time you login to your Yahoo! Account. Now all that remains is to set up your charting tool to show you the buy and sell signals.

Set Up Your Charts

In the screen shown above, click on Chart in the first line (next to the symbol SPY). You should see something like the following screen, where you should click on Interactive Chart:

When the Interactive Chart appears as follows, move the mouse over Technical Indicators and then choose Simple Moving Average as shown below:

Within the next screen that appears, enter “214” on the first line as shown below, to indicate that you want to draw a 10-month moving average on the chart. Ten months is approximately 214 stock trading days. Click Draw.

Next you should see the following chart. We’ll point out some important details below:

To make it easy to see how the current price of your investment compares to the trend line, click on the M button at the bottom. This changes the time frame of the chart to the most recent month. You should see a chart similar to the following:

The 1-month chart provides the best visibility for determining the trades that you should make. If the price and trend lines are too close to call on a given day, then you can position the mouse cursor over that day on the chart and look at the specific price and trend values in the upper left corner, to determine which one is higher. The numbers in the corner will change to show the correct values for any chart day where you position the pointer on the screen.

CAUTION DO NOT USE THE 1-DAY OR 5-DAY YAHOO! CHARTS FOR MAKING TRADES.

These time scales change the units of your moving average from days to some other unit – maybe hours? Maybe quarter hours? Who knows – but YOU WILL NOT GET ACCURATE BUY/SELL SIGNALS FROM THE 1-DAY OR 5-DAY YAHOO! CHARTS. DO NOT USE THEM FOR TRADING.

Now: go back and use these instructions to set up a similar 214-day chart for each of the other 4 investments in your portfolio. Once you have set up 5 similar charts each with the 214-day simple moving average for one of your investments, your base portfolio is complete!

Congratulations! You are ready to begin monitoring your portfolio once per month! See the next page for step-by-step instructions for monitoring and trading.

Step 3: Monitor Your Portfolio

Every Month

Review price and trend for each investment only one day per month, on the same day.

It can be the last market day of the month, first market day, whatever, just try make it the same day every month. Write your day down so you can remember!

To perform the monthly review, we compare the closing price of each investment with its 214-day trend line. If, on the day of your monthly review, the closing price of a given investment (jagged line) has crossed to a different side of the trend line (smooth line) than where it was on the last monthly evaluation day, you need to take action.

HINT Ignore any crossovers that happen on the days in between your monthly reviews. If the price of one of your securities crosses the trend line after your last review and then crosses back over before your next review, ignore it like it never happened!

Here’s what you do:

Repeat this exercise for each of the other 4 investments in your portfolio, and – once you make your trades, if necessary – you’re done for the month! Simple, isn’t it?

HINT Remember: don’t evaluate your investments every day or even every week! You should only evaluate the investments (and buy or sell shares if necessary) one time each month, on the same day of the month.

Chart Examples

Here are some examples of how to read the charts to find out whether you need to buy or sell. In these examples, we are evaluating the price and trend line on the last market day of every month.

Sell Signal

Blue Price Line Crosses Below Red Trend Line Since Last Evaluation Day

Buy Signal

Blue Price Line Crosses Above Red Trend Line Since Last Evaluation Day

HINT You should only make a trade if the chart shows you something different than what you are currently doing. If you are already holding cash for a position when the chart indicates a sell, just do nothing – continue to hold cash. Likewise, if the chart indicates a buy, and you are already holding this security, than just stay put. You only need to trade if: a) you are holding the security and the chart indicates a sell; or b) you are holding cash and the chart indicates a buy.

What if This is Too Complicated?

If you are having a difficult time understanding these instructions or maybe you’re not sure you’re doing it right, then you may want to take advantage of our email alert service that will tell you exactly what and when to trade each month according to this strategy.

You can buy a subscription to the email notice service at our web store:

http://www.grinpress.com

Getting Your Portfolio Set the First Time

If you are doing your very first monthly evaluation, the same technique still applies. If the chart indicates a buy, then you should buy that security. If the chart indicates a sell, then wait until you get a buy signal.

CAUTION If you are just getting started with Pro-Folio, it is possible the current price of a security may have crossed the trend line and produced a “buy” signal a long time ago. So it may not possible for you to make your investment at the level where the On our last evaluation day, May 29, the signal was a sell – but the model was already holding cash, so there was no trade needed for this security. We just continued to hold cash for this position.

Step 4: Place Your Trades if Indicated by the Charts

If your monthly monitoring system has given you a buy or sell signal for any of your investments, you must make your trades as soon as possible. You perform this task by logging into your online investment account and placing the orders to buy or sell.

If trades are signaled by your monthly evaluation, you have two choices, you can:

a) make the trades the same afternoon near market close (4:00 pm Eastern time) if each daily price is far from the trend line and unlikely to reverse, or

b) you can make the trade as soon as possible the next market morning, if you end up having to wait until the market closed to be sure whether a trade was signaled.

HINT Remember: when you buy, you always buy a dollar value of any investment equal to 20% or 1/5 of your portfolio value. And when you sell, you always sell the entire position for any specific investment. There are no partial buys or sales.

How do I Figure Out 20%?

If you don’t know how to determine 20% of your portfolio, just grab a calculator: look at

your account value and divide it by 5.

Account Value ÷ 5 = Amount to Invest in Each Investment.

For example, if your account is worth $73,000, then $73,000 ÷ 5 = $14,600. That is the correct amount of money to invest in each investment type for an account of this size. But when you place an order, you have to specify the number of shares you want to buy, not the overall investment dollar amount. So we have to make one more calculation.

How do I Figure Out the Number of Shares?

To get the number of shares, all you need to do is divide the total amount you want to invest, by the price of one share of the investment.

The Amount to Invest ÷ Share Price = Number of Shares to Buy

Continuing with the same example, if you know that you need to buy $14,600 in a particular investment, say SPY, and the price quote for SPY is $73.50 per share, then you can determine how many shares you need by this: $14,600 ÷ 73.50 = 198.639 shares.

Since you generally cannot buy partial shares, you can just round this down to 198 shares even. That is how many shares you have to buy to move about $14,600 into this investment.

HINT If some of your positions vary in value by a few dollars or a few tens of dollars, don’t worry about it. Proper balancing of your portfolio only becomes a concern when the sizes of your positions become substantially different from each other.

What Kind of Order Should I Use?

In your online investment account, you’ll be able to choose a Market order or a Limit order, and possibly others. For the purposes of the Pro-Folio Original investment strategy, you should simply use Market orders so that you can generally count on your orders getting filled quickly. With a Market order, you are asking to buy (or sell) the investment at whatever price is the going rate. Your order will generally be filled immediately, and under normal conditions it is filled at a price very close to other trades that have just occurred.

With a Limit order, you specify the price that you require for your trade. If the market cannot find a buyer or seller at the price you want, then your order will not be filled until that condition is met.

You can call your investment account customer service line with any other questions about placing orders – they will be happy to help you.

Then What?

After you have received confirmation from your investment account that you have completed all the trades that the model has indicated, then you’re done until next month!

Don’t even look at it for 4 weeks.

Now you’ve seen how easy this investment strategy truly is!

The Ivy League Portfolio lets you spend your time on other things that are important to you! You can rest easy knowing that you are in full control of your investments. And don’t forget, you are saving a lot of money every year doing it yourself!

Step 5: Re-Balance Your Portfolio

Every Six Months

􀃆 􀃆 􀃆 Re-balancing is critically important!

As your investments grow over time, some will grow faster than others. Eventually, you may wind up with your investments divided in very different-sized chunks – for example, maybe 10%, 15%, 30%, 32%, and 13% of your portfolio. Your account is no longer properly diversified! Now the performance of only 2 investments (the 30% and the 32% pieces) accounts for 62% of the performance in your account. If those 2 categories get slammed before you get your next trading signal, your portfolio may not perform according to the model.

Re-balancing means re-dividing your portfolio equally among your 5 investments. You should do this every 6 months. If you have an investment that is 25% of your portfolio, then you need to sell 1/5 of that position to get it back to 20% of your portfolio. If you have an investment that has fallen to 10% of your portfolio, then you need to double that position to 20%.

Rebalancing should never require that you add extra money to your account – your account always adds up to 100%, so by selling the over-allocated investments, you will generate exactly enough cash to buy more of the under-allocated investments. Sell the over-allocated investments first, to generate cash to use for buying the other investments.

Making the Calculations

Here’s how to figure the trades you need to make:

Start with your overall account value, say $235,000. Grab your calculator and divide that by 5 to get your balanced position value:

$235,000 ÷ 5 = $47,000 (balanced position value)

Then take the current value of each position, and subtract the balanced position value to find out how much of that position you need to buy or sell. For example, if you have $65,000 of SPY in your account, then you would figure the SPY trade like this:

$65,000 – $47,000 = $18,000 needs to be sold

A positive result indicates over-allocation (amount you need to sell), while a negative result indicates under-allocation (amount you need to buy). The position in our example is over-allocated by $18,000. So you would need to sell $18,000 of this investment to get back to 20%.

Now if you look back a few pages, you may recall that you can calculate the number of shares that you need to sell by dividing the dollar amount that you need to sell, by the current price of one share of the security. For example, if SPY is currently trading at $98 per share, then you would calculate the number of shares you need to sell like this:

$18,000 ÷ 98 = 183.67 shares

Since you can’t sell a quarter of a share, you would just round the number to 184 shares. This is the number of shares you need to sell to trim this position to 20% of your portfolio.

Repeat for All Five Positions

Once you have made the trades bringing your positions back to 20% of your portfolio, you’re done with re-balancing for another 6 months!

Conclusion

We trust we’ve given you all the information necessary to help you decide when to buy and when to sell portions of your investment portfolio in pursuit of steady performance. While we don’t have any specific information about procedures for opening an investment account at any of the discount broker firms that we have mentioned, please feel free to contact us with any comments or suggestions about this investment guide, or questions about how to set up your monitoring and trading system.

Notes and Explanations

In looking at the annual returns, you can clearly see that the Buy & Hold strategy actually performed better than the Tactical strategy 19 years out of 36, leaving 17 years that the Tactical strategy outperformed. It is important to realize that the Tactical strategy is not designed to provide the very highest returns under every possible market condition.

Rather, this strategy is designed to protect you from the worst markets (for example, 1974, 2001, and 2008) and keep you mostly invested when things are going well. This strategy is likely to underperform slightly during extended periods of rising markets, such as the 1980s and the 1990s. What makes up for this slight under-performance is the downside protection (outperformance) you get during really bad years.

Average Return: This number shows the average annual return over the period 1973- 2008. These returns are before fees. Since no one can invest in an index, any investor (Buy & Hold or Tactical) must subtract trade commissions and the fees embedded in the investments (mutual funds or ETFs) from these returns. As you can see, the tactical trading strategy averaged 1.5% better every year over the period shown. Compounded over 36 years, the result is a difference of 70%. If your portfolio using the Pro-Folio Original strategy reached $1.7 million after 36 years, your buddy’s portfolio just buying and holding the same investments, would be only $1 million at the end of 2008 (30% less).

Volatility: This number is a measure of how severe the ups and downs of the portfolio are, on average. It shows that the tactical trading strategy has much less severe ups and downs than the buy-and-hold strategy.

Max Drawdown: This number measures the largest difference from the highest value of the portfolio to the subsequent lowest value (also called peak to trough). It is a measure of the worst total loss (on paper) that an investor might have experienced during the period in question. Clearly, the Tactical maximum drawdown is much smaller (much better) than that of the Buy & Hold strategy.

Best Year: This figure compares the best one-calendar-year returns between the two strategies. The Tactical strategy falls slightly behind the Buy & Hold strategy in this respect.

Worst Year: This figure compares the worst one-calendar-year returns between the two strategies. The Tactical strategy far outshines the Buy & Hold strategy in this respect.