The Biggest Lesson From My First Melt Up Is Something Many Investors Get Wrong
Editor's note: Longtime Digest readers know all about the "Melt Up"...
Our colleague and True Wealth editor Steve Sjuggerud has followed this story closer – and longer – than anyone we know. In short, stocks often see their biggest and most explosive gains at the ends of major bull markets... like the record-setting one we're in right now.
But the problem is, when the actual peak of this bull market comes, it won't feel like it...
When it's time to actually sell, it'll be the last thing you want to do. Your instincts will tell you that it isn't the end. As stocks turn lower, you'll want to hold on, hoping for a recovery.
In the early 1990s, Steve saw this type of scenario play out in Hong Kong. And in today's Masters Series – adapted from a pair of essays that first appeared in his free DailyWealth e-letter on January 22 and February 5 – he shares what it taught him... explains why a lot of investors get this wrong... and details what you can do to avoid making this mistake...
The Biggest Lesson From My First Melt Up Is Something Many Investors Get Wrong
In 1993, I saw my first "Melt Up" take place...
I was a young stockbroker back then. I lived and worked in the U.S., but I specialized in international stocks.
I didn't realize it at the time, but I'd accidentally landed right in the middle of a stock market Melt Up.
The big story back then was China. Investors were clamoring to get in. My phone was ringing off the hook. Folks were cold-calling me... looking to open an account... something that doesn't usually happen to you as a broker.
But because I had access to the Hong Kong market, I could get them what they wanted – Chinese stocks. That made me "Mr. Popular." The phone kept ringing... until it didn't.
You see, every Melt Up ends the same way... with a "Melt Down." And even if it doesn't happen tomorrow, we've got to remember this lesson today.
Let me explain...
I had no idea I was in the middle of a Melt Up when all this was happening. But looking back, it was so obvious.
Our group of young brokers came to work giddy every day. We were making more money than any people in their twenties probably should.
Everybody wanted to buy. And we were the ones who could get you in...
Hong Kong stocks roughly doubled in less than a year. Then, the bottom fell out. You can see what happened in the Hang Seng Index, the main stock index in Hong Kong...
It began with a 10% fall in a month. The young guys in our group started getting nervous... "Is it over?" I wondered.
Heck no! The phones kept ringing. People who missed the earlier run-up scrambled to buy.
Prices kept falling, but my customers didn't give up. The phones were still ringing.
Customers would call every day to get quotes on their holdings. (It was still in the early days of the Internet, so it was tough to get prices back then.)
I'd have to give them the bad news... every day.
At first, customers wanted to "double down." They wanted to buy more shares – to "lower their average cost." They were certain China would run back up. But they were wrong.
The grim reality set in. The late-1993 China Melt Up turned into the 1994 China Melt Down.
I wanted to hide under my desk. My monthly income – which was all based on commission – fell roughly 90%. I went from the top of the world to, well, nearly broke.
The experience was awful. But it's where I learned the most important lesson of that Melt Up...
If you want to ride a Melt Up, you must have a plan to protect yourself from the inevitable Melt Down.
Many of my customers back then had no plan for the Melt Down. They never lost hope... So they sunk their portfolios as they held on and hoped.
And that leads me to the second part of today's essay...
What's the biggest thing investors screw up?
I've thought a LOT about that question. And I know that the answer will help a lot of folks avoid big losses.
Investing is full of pitfalls. Even if you buy the right investment, your trade can go south in plenty of different ways. And after years of writing and talking to my readers, I think I've uncovered the most obvious issue...
Most investors – like my customers in the mid-1990s – have no idea when to sell.
This is a tough realization for many. When you're clicking "buy," you don't want to stop and think through what would cause you to sell. It's exciting to make an investment... No one wants to kill the thrill with the homework of selling.
The problem is that a great trade is made up of two things... a great buy and a great sell.
The biggest thing investors screw up is only worrying about the buy. But you can solve this problem with a simple step. Let me explain with another example...
To this day, Seabridge Gold (SA) is the best-performing stock recommendation of my career.
I recommended it back in July 2005 in a high-priced, speculative newsletter I used to write. Shares of this best-in-class gold explorer went from around $3 to more than $30 by the time we sold in 2009. Subscribers who followed my advice locked in a 995% gain.
As you can see below, though, that decision to sell was important. The stock ultimately gave back all of its gains... It traded for around $4 a share in 2015. Take a look...
Today's price of about $13.75 a share is 50%-plus below where I told readers to lock in profits in 2009. The problem is, I know many folks never sold.
I've spoken to dozens of readers at conferences who bought Seabridge on my original recommendation... and held on to it years after I recommended selling. They rode it all the way up... and all the way down.
Our subscribers at Stansberry Research often take our buy advice... But for some reason, they don't always sell when we say sell.
Now, that's fine... if you have a different exit strategy that happens to work for you.
But I've learned that most investors have no exit strategy at all...
Either they don't want to sell when they're up because they think more gains are coming, or they don't want to cut their losses when they're down.
Sometimes "holding and hoping" might work for you – by chance. The problem is, "hanging in there" is not an exit strategy. If all you're doing is hoping, you have no control. You are not investing based on risk and reward.
So the day you enter a trade, make sure you know what will cause you to exit that trade.
This is how I'm approaching the Melt Up today...
I believe we'll see a furious blow-off top in the market in the coming months. But I also know that the Melt Down that will follow could be swift. That's why I use stop losses to know when it's time to sell.
All this means is choosing a point where you'll exit the trade...
You can use a hard stop at a specific price (for example, a recent low). Or you can use a trailing stop that follows your investment as it rises. I often use a 25% trailing stop loss for my investments. That means if the stock falls 25% from its high, I sell – no questions asked.
It doesn't matter which kind of stop you use. What matters is having a plan to sell... and sticking with it. That's how we'll hold on to our Melt Up gains. And if I'm wrong about the Melt Up entirely, we're covered, too.
So make sure you have an exit plan for every investment. And don't go against it... If you do, you will always come up with an excuse not to sell.
Good investing,
Steve Sjuggerud
Editor's note: Steve doesn't want investors like you to make the same mistake his customers did with Hong Kong stocks in the early 1990s. Even if the market keeps running higher, he believes you're playing a dangerous game if you don't have an exit plan in place.
If you're reading this message, Steve wants you to look in the mirror and ask, "What am I going to do when the 'Melt Down' comes?" And if you don't have an answer to that question, you must watch his recent on-camera interview... In it, he explains the No. 1 thing you can do right now to protect your wealth. Watch Steve's interview right here.