If You Must Gamble... Use This Humble Tool

By Vic Lederman, analyst, True Wealth

"Vic, I'm not gambling... I'm investing."

Sure. And I bet that's just what folks thought when they loaded up on JC Penney right before it declared bankruptcy... They were "investing."

Listen, I get it. The market is hot right now.

Volatility is back. People are making, and losing, a lot of money. And it's happening fast.

Morgan Stanley's traders are a great example. They just hit a home run. And the investment-banking firm is making record profits. In fact, Wall Street's five biggest banks just raked in roughly $33 billion last week... all thanks to their traders.

So really, I get it. Mom-and-pop investors want in on the action. And if you're one of them, I don't blame you.

The thing is, all this has turned a lot of "investors" into gamblers. And they probably don't even realize it's happened.

Now, I'm not going to sit here and tell you not to gamble. We all know that a decent chunk of you are going to do it. But if it's at all possible... I'd like to help you gamble just a little bit more safely.

Today, I'm going to cover an essential investment tool. It'll sound simple. But whether you're investing or gambling, it could save you from losing all your money...

Yesterday, I told readers about mom-and-pop investors losing their shirts on JC Penney, a dying department store. Those folks piled into the bankrupt company's stock, hoping to lock in big profits in the event of a buyout.

Now they're begging the judge in the bankruptcy case to save them. It's almost too crazy to believe.

Let me be clear... Gambling like this is almost always a bad bet. But if you're going to do it, you need a tool to help you know when to walk away.

That's pretty basic right? Every skilled poker player knows when it's time to get up from the table. (Well, at least every skilled poker player who keeps his winnings.)

So, how do you know when to walk away? I'd like to recommend the humble trailing stop.

We've written about it a lot in DailyWealth. It's a basic investment tool that helps you know exactly when it's time to walk away. And at the same time, it helps you lock in profits.

The way it works is simple. You simply choose how far the stock will fall from the last highest price it hit – based on a percentage – before you sell. A good place to start is with a 25% trailing stop.

So, if you buy at $20 a share... and it soars to $100 but falls back to $5 over the next few months... that's OK!

The trailing stop would have gotten you out of the trade at $75. That's because $75 is 25% down from the peak price of $100. So even though the stock eventually crashed, you would have locked in a 275% gain.

Let's use car-rental company Hertz Global (HTZ) as a real-world example. This is a stock that nobody should have bought. The company has been dancing with bankruptcy after filing for Chapter 11 in May. And last month, it announced a half-baked plan to issue more shares... even though it admitted that the stock would almost certainly be worthless.

Through all of this, volatility reigned supreme. Shares soared... then crashed back to Earth. Still, even with this terrible setup, you could have made money if you'd used a trailing stop.

Let's pretend you have perfect foresight... and that you bought in the exact day before Hertz shares exploded higher.

Here's what the humble trailing stop would have done for you...

Look at that! An investor with perfect foresight and a 25% trailing stop could have walked away with a 200% gain. And with a tighter stop, you could have done even better.

Now, of course, none of us have that kind of foresight. This is a crazy example to look at. But it does highlight the point well. Even jumping into an ill-advised mania can leave you with gains instead of losses – if you use this simple exit strategy.

At the end of the day, I can't stop you from gambling. But if you must... If you believe that you've found the perfect bet... If your mind is screaming "buy" even though all the data says not to...

Please consider the humble trailing stop. You're going to need an exit strategy to get out of your trade. And if you're really lucky, you might just walk away with some winnings.

Good investing,

Vic Lederman

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