True Equity vs. Market Equity

Everybody has a different level of expectations and commitment when it comes to managing their own money. If you are a real student of the game, then what I'm about to share with you will absolutely change the way you quantify risk throughout your investment portfolios.

Investors are becoming much more sophisticated than they had been in the past, and we're seeing more and more non-professional traders bringing real "best practices" risk management to their trading.

One of the most important best practices (and the one I harp on the most) is governing your position size by your stop-loss point. That is, selecting a maximum amount of money (typically based upon a percentage of total portfolio value) you are willing to lose on a single trade, should your stops get hit.

Most hedge funds won't risk more than 1% to 2% of their equity on a trade. This means that, if their stop gets hit, they only lose 1%-2% of their portfolio value. It does not mean that they only invest 2% of their portfolio value at a time. For information on this strategy, visit this link.

This method of position sizing is based upon only risking a set percentage of your total account value. What I want to do today is share with you a big pitfall to avoid when using this approach.

What's Your Portfolio Really Worth?

When new investors learn of the position sizing technique, they immediately set about basing their percentage of risk against their total account market value.

If your total account is just cash or cash equivalents, then that's fine. If it's not, meaning that you're basing your equity on the market value of the stocks and commodities that you own, that's a mistake and I'll explain why.

Let's say you have a $9,800 portfolio, and you have seven different trades on and 100 shares of each stock. For simplicity's sake, let's also assume the following:

Share Stop Current Market
Amount Price Price Value

100 Stock A $12 $14 $1,400
100 Stock B $12 $14 $1,400
100 Stock C $12 $14 $1,400
100 Stock D $12 $14 $1,400
100 Stock E $12 $14 $1,400
100 Stock F $12 $14 $1,400
100 Stock G $12 $14 $1,400
= $9,800 TOTAL EQUITY

This means that any positions that you initiated off the 2% of $9,800 in equity would now represent a risk to your portfolio of 2.33%.

That a 16% increase in risk to principal!

That doesn't sound like a lot with the small numbers I've used in this example but, as your portfolio grows, the impact could be for huge dollars.

The solution is to value your holdings based upon their stop-loss price, not their market price, and basing all new purchases off that discounted valuation.

How Much Do You Really Have at Risk?

By calculating your equity based upon pricing your holdings as if they were selling at your stop price, you create a much more robust risk model for your portfolio. The reason why you should consider using this approach is because you don't want exponential risk exploding through your portfolio if your trades get stopped out.

I call this "true equity" vs. "market equity."

"True" equity is always what you would have if every trade were stopped out. "Market" equity is the equity you have based upon your current market value.

Market equity is always in flux; your true equity adjusts higher or lower as you raise or lower your stop prices.

So if we use the fictional $9,800 account above, you are risking 2% of total portfolio value per trade, or $196. To apply the true equity value rules, we have to remember that the 2% risk parameter is on a sliding scale based upon the cash in your account and the "stop" value of any open positions.

So, while your first trade may allow you to risk $196, your other trades may not. It will depend upon the most current value of your "true" equity.

Using the above example of the seven trades, we would value each stock not at its market value of $14 but rather at its stop-loss value of $12. Any new position would be based off a true equity value of $8,400, not the market value of $9,800.

Guard Against 'Gap Risk'

Let me go over it again: We work out "true" equity by valuing our holdings as if they were trading at their stop prices, plus any cash or cash equivalents we hold in the portfolio. The number that we get is the number we use to base our position sizes on, not our market value.

Basing your position sizes off true equity has another advantage to it. If you trade any security, you will always have "gap" risk. Gap risk, or "skid," is when a security "gaps" below your stop-loss point.

There's not a whole we can do to mitigate gap risk. I employ the above true equity rules as one method to blunt the impact of gap risk on my open positions. (Owning Exchange-Traded Funds in lieu of common stock is one way to dramatically reduce the impact of "gap" risk.)

I've had stocks that were profitable based upon market value, and at breakeven based upon my stop-loss price, that have gapped right through my stop point to turn a winner into a loser.

Let me explain that further: Suppose I own the stock at $20; the stock is trading at $22 and my stop is at $20. On a market value approach, I'm up 2 bucks but on a true equity value approach, I'm at even.

On a gap down, that stock could gap open at $18 -- right through my stop. This is a very real risk, especially around earnings time. This is another reason why I base new buys off my true equity rather than market equity. It does a lot to protect my account from market "skid."

Don't Let Overexposure to Risk Leave You in the Cold

You also need to determine how much total equity risk exposure you are willing to assume. In the above example, we used seven trades, with each trade risking approximately 2% of our account value (based upon the stop-loss price) for an aggregate exposure to the portfolio of 14%.

This means that, if we assume no gap-down moves and that every stock was stopped out, the total portfolio would sustain no more than a 14% loss of principal. Again, your principal capital, or true equity, is based upon valuing your holdings at their stop-loss price, not their market price.

The number you choose is going to be based upon your own risk tolerance, and I've seen it vary from 10% to 100%. For my own trading, I don't like having more than 15% to 18% total exposure. This means that, if every position I own gets stopped out, my accounts will lose between 15% and 18%.

As your positions appreciate in value, you can raise your stops, which will make available more true equity that you can use to increase your position size.

By the way, I discovered all of these lessons the hard way as I watched risk balloon through past portfolios, blowing my risk assumptions to smithereens. At first I put it down to "bad luck," but that was just an excuse for not digging deeper. It was only when I really examined the systemic impact of each trade that I came to see where I had gotten it wrong.

A Tale of "Two Markets"

NASDAQ vs. A/D line (overlap,) 2-year daily chart

Individually, the vast majority of "market forecasting systems" and "trading systems" on the market today have limited usefulness – something you may know from first-hand experience.

Most are – to put it mildly – inaccurate. Worse, those financial advisers who are occasionally correct in predicting broad market trends don't help you profit from them – because when it comes to finding individual stocks to capitalize on those trends, they haven't a clue.

On the other end of the spectrum, there are many technical trading systems out there. And some of their charting techniques are quite useful for finding bottoms and tops.

But the problem is they don't tell you where to focus your attention. You gain some charting techniques to help you time trades. But they don't tell you which markets, sectors, or stocks to look at.

My Internal Strength System combines the best of both worlds, and the flaws of neither.

First, I'm going to help you understand that there are, in fact, two stock markets out there ...

One is the external market, the market that most investors see day in and day out.

This includes the S&P 500, the Dow Jones Industrial Average and other major indices.

The "external market" is the stock market that most people use to tell them what already happened. It's also the stock market that's responsible for most investors losing money on the vast majority of their trades.

But right beneath the surface of the external market is what I call the "internal market," and that's the market you need to understand to grow very, very rich.

Turn on the TV and the radio, and what's the main financial news of the day? It's whether the Dow is up or down, and how many points it rose or fell.

The Dow Jones is what the "Joe Investor" uses to identify the market's trend and risk. But it's a highly inaccurate indicator. Not only is the Dow Jones average disproportionately price-weighted ... but it is based on only 30 stocks!

You could turn to the S&P 500 to get a clearer picture of the market's internal strength. But again, watch out!

The S&P 500 is based on 500 stocks, not 30. But the biggest 50 stocks make up half the weight -- and contribute to half the index's movement. So, tracking the S&P 500 doesn't give you a fair picture of where the market is heading, either.

I reveal the only way I know of to truly gauge the market's inner strength, direction, and risk ... and believe me; it has nothing to do with watching the Dow or S&P 500.

Let me give you a sneak peek into how we determine that the external market is showing strength as the internal market is breaking down.

The chart, illustrates the Nasdaq Composite Index (which represents nearly 3,000 stocks that are traded on the Nasdaq Stock Market) and it illustrates that index's Advance / Decline line (we'll call it the "A/D line" for short) which is overlapping the Nasdaq.

The A/D line is the squiggly red line that's higher on the left side of the chart and then falls below the black squiggly line (which represents the Nasdaq Composite) on the right side.

I've put some blue arrows on the right side of the chart to clearly point the A/D line out to you.

What the A/D line shows us is the cumulative difference of the number of advancing stocks vs. declining stocks. On any given day when a larger number of stocks increase in price, the A/D line moves higher. And on days when a larger number of stocks decline, the A/D line moves lower.

The direction of the line as it relates to the movement of the Nasdaq is what's most important to us.

When the A/D line moves in the opposite direction of the Nasdaq (or any other index for that matter), the index usually ends up following the direction of the A/D line.

So, if the Nasdaq is going higher and higher, but the A/D line is falling lower, that tells us that only a small number of stocks are responsible for the increase in the index. It's a sign of weakness.

If the Nasdaq goes up, and A/D line goes down, we call it a "divergence." A divergence works the other way around too... if the index goes down but the A/D line goes up. But, in that case, it's a sign of strength.

Now focus your attention on the right-hand side of that chart.

You can see that the new highs made by the Nasdaq (circled in red) are not being confirmed by the A/D line. This is a huge red flag. It means that fewer and fewer stocks are actually responsible for pushing the Nasdaq higher.

Near the first two blue arrows, you can see that the A/D line was making lower highs while above that the Nasdaq made higher highs. That was followed by a big drop in the Nasdaq which is indicated with that vertical pink bar.

Can you see above the last blue arrow that there's an even larger divergence? What do you think is going to happen next?

If you said... the Nasdaq is going to go down, you're correct.

That's exactly what happened. And thanks to the A/D line, we were able to predict that and profit from it.

Now, don't just run out and start betting the farm on market moves based on the A/D line.

There's another simple indicator that you must look at first in order to confirm what the A/D line is telling you about the direction of the real market.

Once you learn how to do this, you'll be able to make money, while the market is dropping.

For example...

Back in October 2007, the external market was running and gunning. The S&P 500 reached a high of over 1,565 ... the Dow had broken 14,000 and was heading higher. Everything was positive, and individual investors were pouring tons of money into stocks.

But behind the scenes, it was a different story altogether. My internal market indicators, including the A/D line, were flashing warning signs, telling me that the REAL stock market was showing serious signs of weakening.

What did I do? I pulled the trigger on numerous bearish trades – I took positions in stocks and options that enabled me to make money from the drop in the stock's price.

Just as I expected, the external market (S&P 500) lost more than 3% over the course of two weeks. During that period, while most investors were seeing red, our positions were up 13%, 26%, 25% and 47%.

It wasn't magic or a lucky guess.

The point here is that I knew that move was coming because of a few, very simple indicators that I look at each day confirming the direction of the internal market.

The most important thing for you to remember is that the internal market LEADS the external market.

The Lazy Man's Way to Get Rich

I am getting ready to take the biggest risk of my entire career by releasing every detail of my investing system – every single trick in my investing playbook – to the general public in my Internal Strength System ...

How did I go from thinking this was a stupid idea that would make me obsolete to releasing this course to a select group of eager investors?

$25,000 Down The Drain

Last December, I began to research home-study investing education courses. Naturally, I was skeptical of the claims many of them made in their ads. But I figured if I could find just one good one, I'd be able to recommend it to others.

I won't mention any names, but I spent $25,000 buying the five most popular investing courses I could find. Each course was delivered to my house in big boxes and beautiful wrapping. Each course contained a nicely bound book and several DVDs.

But what I discovered next was shocking: Half of the DVDs looked like PowerPoint slides created by teenagers. The other half seemed to have been filmed from the back of a lecture hall with horrible sound and visual quality.

But that wasn't the worst part. The worst part was that the methods these so-called "experts" were teaching people were completely theoretical and totally useless out in the real world!

I had personally proven half of their theories wrong in the past five years alone with real-life experience! I couldn't believe my eyes: You'd be better off never watching any of these videos.

Did these people know they were doing more harm than good?

After months of seeing these newsletter guys screw it up, I realized that I had to step in here and shed some light on this subject. So what I decided to do is put together a step-by-step educational program that will empower you to invest like a professional.

I knew we had to create the "ultimate" investing course, but the truth is we didn't know where to start.

Hollywood Meets Wall Street

But that all changed when my colleagues Dylan Jovine and Ben Schott went to Los Angeles to meet Hollywood Producer, Rene Besson.

Rene's not just your average Hollywood guy – he works with some of the biggest names in the business. And he's been a friend of Dylan's for years.

The idea was to ask him for some recommendations for a professional film crew, and to have him walk us through some of the hazards of doing this.

We wanted to do it right and there's no better way to start than by talking to a professional storyteller.

What happened next truly astounded us.

He say that he would love to help us with this project because it would mean a lot to him. As somebody who also started from humble beginnings (he slept in his car when he started out in Hollywood) he immediately saw the impact of doing this.

(Indeed, he was so excited about the project that he even offered to do it for free at first – until he saw how big of a project it was!

Within a month he had cleared his calendar and we were off to the races.

Fast-Forward to Today ...

I literally put everything I have ever learned, known and done into this course. I can even say I've put my heart and soul into this course.

In the back of my mind the entire time I kept thinking of the millions of working people who have been fleeced for billions by the Wall Street machine.

If you're currently making less than $200,000 per year ... or have less than $1 million in the bank ... the educational series that you have begun could save your hide.

You see, most Americans are facing a serious crisis.

According to a recent Harris poll, 88% of all U.S. citizens at or near retirement age are severely under-funded when it comes to retirement ... and face going broke once their careers wind down.

However, a handful of average Americans have sidestepped the retirement trap, exploded their income and multiplied their wealth in an amazingly short period of time.

They've discovered a "private game plan" that can absolutely do the same for you ... and much faster than you might think.

I'm talking about a blueprint for wealth that has already helped over 1,500 ordinary people go from living check-to-check, mired in debt, with very little in savings to being on the road to becoming financially independent multimillionaires.

It is time that we deprogram you from everything you have ever learned about investing ... and start fresh.

So clear your pre-conceived notions and get prepared to learn how to make serious money.

There comes a time in every person's life when they have to make a decision.

For me, it was on that day that doctors told me I would never walk again. A freak accident had left me paralyzed from the waist down.

I was 16 years old, never cared much for school and had never given much thought to my future. In other words, I was a typical 16-year old.

Of course I was angry. And for a couple of years I was very bitter.

But I remember my father once saying to me that it's not the hand you're dealt in life but how you play it. And somewhere deep down inside I knew he was right.

In the weeks and months that followed it occurred to me that I had one of two options: I could be a victim for the rest of my life or I could fight.

For me the decision was easy: I decided to fight.

What was I fighting for? I was fighting for my future ... for my physical and financial independence.

To this day I don't know what snapped in me, but at that very moment I swore to myself that I would become independent.

How was I going to do that? The truth is, I didn't have the first clue. But I had a mentor who taught me everything that I'm about to teach you ...

4 Simple Steps to a 7-Figure Income

Step 1 – Identifying the Trend & Condition of the market: I'll show you exactly how to identify the overall direction of the REAL market. Most people focus on the Dow, Nasdaq and S&P 500 ... but you'll find out just how big a mistake that can be. When you understand how to determine the overall direction of the ACTUAL market, you'll know precisely how bullish or bearish to be in your positions. I'm going to be teaching you a complete strategy, which provides several different tools that, when used together, will help you determine where the market is heading.

Step 2 – Understanding Relative Strength & Sector Rotation: We'll focus on the importance of relative strength when choosing your investment vehicles and how to use relative strength and Bullish Percent Index charts – two of my favorite indicators that help me to consistently pick winning options trades – to drill down to the strongest and weakest securities.

Step 3 – Reading and Understanding Charts – By understanding the implications of various chart patterns and the indicators that confirm them, you can narrow the timing of your trades down to the second. Understanding how to read charts will greatly improve your odds of success.

Step 4 – Action: Here's where you'll learn to put your analysis to work. This is the money management section of the series. You'll learn how to reduce your risk, increase your potential profits, and hedge your investments.

I have no doubt that this series will give you the knowledge and confidence to begin paving your path to financial freedom. Say good-bye to your day job. Retire with confidence – much earlier than you ever thought. And live the life you've always wanted to. Welcome to the Internal Strength System!