About a dozen years ago, I found myself having a stimulating conversation one sunny day in San Francisco with the great economist Milton Friedman.
It’s a conversation I’ll always remember.
I studied economics in college – in fact, I’m the recipient of an honors degree in that subject – and the tireless free-market advocate was and remains one of my big heroes.
We were standing on the balcony of his spacious Nob Hill condo taking in the sweeping Bay views and talking about economics and Washington politics – as I eyed the huge portrait of him standing in a corner that Friedman’s wife hated and wouldn’t let him hang. Then he looked me in the eyes and said, “You know, Michael, I’d like to see the Federal Reserve replaced by a computer.”
As the 1976 Nobel Prize in Economic Sciences laureate explained it, he felt the Fed had become too obsessed with micromanaging the nation’s economy. Remember, this was a dozen years ago, before the Fed started quantitative easing and heavily manipulating interest rates.
Of course, I’m not suggesting we replace the Fed chair with a robot.
But I always recall Freidman’s thought experiment whenever the markets get choppy, as they have in the past few weeks. And when I see the markets become volatile because of the Fed and the news, I know it’s time for defense.
I’ve before shared with you my five “Choppy Market Tools.” But today, I want to share with you a classic investment strategy that I’ve given a brand-new nickname to reflect our focus on the “New West” of Silicon Valley tech stocks.
I call it the “Cowboy Split.”
And today I’m going to show you that when employed properly the Cowboy Split will protect you from volatile markets.
If your stocks go down, on the recovery, you make more money…
Rounding Up Profits
Back on June 27, I told you I believe we are still in the early stages of generational bull market. That’s one that could run for up to two decades.
The U.S. economy continues to gain momentum.
Cars and light trucks are selling at an annual run rate of 16.3 million units. We’ve had the best five-month stretch of job gains in several years. And we just learned gross domestic product (GDP) expanded at a 4.0 percent annual rate in the second quarter.
Tech is again leading the way with high corporate profits, strong cash flow and great operating margins.
However, in that report, I also said that we would see setbacks along the way. No bull market advances without occasional corrections and sell-offs.
Indeed, the markets recently become more news driven than usual.
Fed Chair Janet Yellen‘s remarks about “stretched” small-cap, biotech and social-media stocks spooked the market for a couple of days. And investors are also concerned about Argentina‘s second bond default in 13 years, Israel‘s offensive in Gaza and Russia‘s connection to the downing of a Malaysia Airlines passenger jet in Ukraine.
On top of all that, I’ve spotted a depressing trend this second-quarter earnings season – companies with the slightest hint of trouble see their stocks quickly sell off.
But I’m not worried. This is a great time to take a defensive approach to investing in tech stocks.
In fact, I think I’m getting a reputation for my defensive splits.
I have regular late-night strategy sessions with my good friend Money Map Press Executive Editor Bill Patalon.
When I phoned the other night to discuss market conditions, Bill came on the line and said, “Hello, Mr. Cowboy Split.”
If that sounds a bit silly, that’s because my defensive strategy – the Cowboy Split – is hardly academic. However, it is a very effective approach. And my readers through Nova-X Report and Radical Technology Profits have used it to make some good money in recent months.
Let me explain how the Cowboy Split works. In a nutshell, you make “split entries” when you acquire shares of a great tech stock.
With this process, we buy a one-half or one-third entry at market, and then put in a lowball limit order to pick up the rest should the market or the stock itself retreat.
To help you better understand the Cowboy Split, I’m going to mosey through two examples… and then we’ll watch together as your profits rise.
Cowboy Split Play No. 1
Let’s say you have your eyes on our most recent recommendation, Hewlett-Packard Co. (NYSE: HPQ). It’s selling at $36 a share. The company is in the midst of a successful turnaround, and developers there are hard at work on a blockbuster piece of tech hardware known as “The Machine.”
Let’s further assume you want to own HP for the long haul. You can use the Cowboy Split to buy on the dips and increase your overall stock profits.
Here’s how you do that. You start by investing half of your standard stock purchase at market, in this case $36 a share. As soon the market order fills, you enter what’s called a “lowball limit order.”
You tell your broker that you want to buy a second tranche of HP at a much lower price. I usually use a 20% discount for filling the second half of a Cowboy Split.
You would then enter a “limit order” for the second round of HP at a price of $28.80 or lower. If the stock falls to that price, your order automatically fills, and you now have an average purchase price of $32.40.
Once the stock resumes its climb, you have baked in extra profits. For instance, when HP hits $43.10 a share, your cumulative gains are now 33%. ($43.10 minus $32.40 divided by $32.40 equals 33%.)
Had you bought all the stock at once and held, your returns would have been 20%. ($43.10 minus $36 divided by $36 equals 20%.)
So, the Cowboy Split increased your profits by more than 50%.
But what if the stock doesn’t correct and your lowball limit order doesn’t fill?
No, you didn’t increase your overall gains. But you did get portfolio insurance for free.
Cowboy Split Play No. 2
There’s a variation on the Cowboy Split that many pro traders employ. This entails cutting your entries into thirds. Traders do this when they want to pick up more shares at a discount but don’t expect a reversal of more than 10% or so.
You put in an order, at $58, for a one-third position and then put in two lowball limit orders. The standard amounts with this approach are a 10% discount on the second tranche ($52.20) and a 20% discount on the third ($46.40).
If the second two orders fill, and you get an average price of $52.30, then you once again would build in extra profits when the stock resumes its climb.
If the stock climbs to $69.60, your gains are again 33%. ($69.60 minus $52.30 divided by $52.30 equals 33%.)
If you had bought and held, knock that gain down to 20%.
As you can see, the Cowboy Split is a powerful investment management tool. It’s a great way to play defense when a bull market turns choppy, as it has in recent weeks.
And with this approach you won’t get left on the sidelines once the uptrend resumes.
By making staggered entries, we turned market setbacks or declines in individual shares to our strong financial advantage.
So, if Mr. Dow has an anxiety attack, then Mr. Cowboy Split has a plan: Buy great tech stocks at a discount… and make even more money in the long run.
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