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The One Rule That Could Save Your Portfolio + Vic Wisemann’s Thoughts on: GE, AMZN, IBM, XTO, CHK, UNH, EBAY, INTC and More...

Vic Wisemann
InvestorsObserver
Featured Contributor

The market has been doing a very fine impression of Jekyll and Hyde so far this year. Looking at either the Dow Jones Average or the S&P 500, the market started out the year by basically heading down for two months straight, hitting a low on March 9th. Then came two months of generally positive movement, culminating around the 8th of May. Are we now in for two more months of prices sliding down? I don't know the answer and neither does anyone else, no matter what they say on the news.

So far this year the market is down, depending on which index you look at, 2% to 5%. That shows the volatility in the market this year. From the high in January to the low in March, the market shed over 30% of its value. That is on top of the drop in 2008. Equities almost made it back before their recent turn back to the dark side.

Read on for the rule that can save you headache, heartache and cold hard cash.

With the market doing its best impersonation of a wave, what are investors to do? In any market, but especially this one, you have to have rules. More important than having the rules, you must follow them. If you don't follow your own investing rules, then you really don’t have any and you are basically shooting from the hip.

While I have a few friends who use this method successfully, more often a lack of discipline leads to big losses. When you start to read something about discipline, you might think about some US Marine drill sergeant or a tanned and toned fat farm nutritionist who wants you to survive on seaweed sandwiches. Both those images of discipline could cause some discomfort for most people.

The kind of discipline I am talking about is investment discipline, and hopefully there will be very little pain involved. In fact, using a little more discipline when investing could make your portfolio easier to manage, better organized, and give you more predictable, consistent results.

There are hundreds of rules you could set for your investments, but today there is one which could save you a lot of money in the long run. The rule to which I refer is the 5% rule. You may not have heard of this one but it is really simple.

The 5% rule works like this. You enter a position and, if the stock falls 5% from a predetermined level, you sell -- period. There is no hesitation, no questions asked; just sell. The stock may turn and you will miss out on some profits but you will feel a whole lot better than losing another 30% and then selling.

It is very simple and easy to follow. You buy a stock; say General Electric Co. (GE) or Amazon.com Inc. (AMZN), or even International Business Machines Corp. (IBM). On the first day of the trade you use your entry price as the standard for your exit. A 5% drop and you exit the trade. As time passes and the stock rises in value, each new high becomes the standard from which you watch for a 5% drop.

The only problem is the current volatility in the market. Over the past six months, stocks -- even stable stocks-- have moved more than 5% in hours, causing havoc to investors and traders alike. The question becomes how you can invest and still keep your sanity.

The strategy I like to use in this market is the call debit spread. You can give yourself protection to the down side and still have decent profits. If the stock falls off, you have more options to exit or modify the trade.

Here are a few stocks I have recently been looking at for this strategy. In the Basic Materials sector, I would consider looking at XTO Energy Inc. (XTO) and Chesapeake Energy Corporation (CHK). From Health Care, Unitedhealth Group, Inc. (UNH) has some possibilities. And in Technology, eBay Inc. (EBAY) has potential, and even Intel Corporation (INTC) has potential, despite their EU issues.

There is a nice trade out there on XTO. For a hedged trade on XTO, you may want to consider the June 35/31 bull call spread for a 3.50 debit. The trade would result in a 14.3% profit and the stock could fall 15% and the trade would still have a profit.

With the call debit spread you can still utilize the 5% rule but you have more options. If the underlying stock falls more than 5% from a certain level, you can close the position completely. You will take a small loss but will still have capital to use in another trade.

If you believe the stock will probably go back up before expiration, you can buy back your sold call. This allows you to benefit if the price goes back up. The danger here is the stock continuing to fall. If you choose this route, you should consider setting another 5% limit and if the stock falls below, then sell the long call.

The key is to keep involved in the trade and take action. There is no worse feeling in the world than seeing a trade gone bad and saying I wish I had done something. Set your goals and limits and your rules of engagement and stick to them.

These are exciting times in the market and you need to be confident in your trades. Be sure you understand the risks of a trade before you put your money at risk. Don't risk money on trades that don't fit your goals and tolerances; just watch those from afar. Do your homework, understand the trade, and have a little fun.

If you have had any additional thoughts, insights or ideas for making sweet profits in this market, please e-mail me at vwisemann@InvestorsObserver.com.