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Defend Some Stocks, Not All



Rule 9

When the markets are hard and unrelenting, as this one has become this year, it's important to remember an adage that's well-suited for a battlefield plan but is just as valuable for a portfolio plan:


He who defends everything defends nothing.


When the market's flying and many stocks are in a bullish mode, it really doesn't matter how much you have on, or how many positions you have. The more exposure the better.

But when things get tougher, you have to recognize that many stocks that you bought for better times may not be in good enough shape to rally. You can't own everything you would like to own.

For example, last March you may have been playing the chemical sector with Eastman Chemical (EMN - news), Dow Chemical (DOW - news) and DuPont (DD - news) because you saw the demand from China. But when General Motors (GM - news) suddenly "blew up," you had way too many chemical companies.

I like to say, don't defend them all, just defend some. Pick your favorite and defend that. If you try to defend them all, you simply will run out of capital or go on margin before the bottom. You will lose your reserve and not be ready if the market doesn't turn in your direction.

That's why I rank all my stocks at all times for my Action Alerts PLUS portfolio. I need to know which stocks I will defend when things get tough and which I will cut and use as sources of capital.

It's extremely important, say, if you think that the techs are going to start rallying here, that you don't just keep the whole complex. Pick the best stocks, the ones you know you will want to buy if they go lower and toss out the rest.

Let me give you an example. Say storage stocks seemed to be holding up rather well under tough market conditions and that sector struck me as worth defending. But that might mean I'd toss out a software stock that I was more worried about or eliminate an Internet stock because I couldn't know when it would reverse. I would defend, only, say, QLogic (QLGC - news) or Brocade (BRCD - news), but not both.

If you rank stocks on a scale of one (buy) to four (sell), as I do at the end of every week for Action Alerts PLUS, you know that when you come face-to-face with the enemy — an onslaught of selling — you are ready to buy on the way down the ones you can truly defend — the No. 1 stocks — and you will wait on the twos until they are lower.

The nonessentials — the ones that have no catalysts and that you are using just for exposure because you thought you liked the market — they get the heave-ho immediately.

My wife, the former Trading Goddess, used to call this "circling the wagons" around your best names. The few first times you do it, you will curse yourself because you will be slaughtering stocks you might have had on for some time.

But you must go through this process a multitude of times before you realize how right it is and before it can become second nature.

You will end up with great costs bases on the stocks you really like, and you will have enough capital left to make a difference.