Jeff Remsburg

From Jeff Remsburg, editor-in-chief, Palm Beach Research Group: You are the single greatest threat to your portfolio.

You’re not alone. I am an enormous threat to my portfolio. I’ve proved as much on many occasions.

As humans, we’re not wired to be great investors. Our natural aversion to loss, coupled with occasional, irrational greed, can lead to awful investing decisions.

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Today, you’re going to see this dynamic play out. I hope you’ll take away two pillar investing concepts. If you follow them, they’ll go a long way in protecting you—from yourself. If not, the outcome can be devastating—as you’re about to see…

Catching a Falling Knife

Six months ago, a coal company called Peabody Energy (NYSE: BTU) appeared on my radar.

The coal industry has come under immense pressure over the last few years. The Environmental Protection Agency has pushed for tougher emission limits on coal-fired power plants. As a result, some of the biggest players in coal have watched their stock prices gutted since 2011.

However, there’s still a huge global market for coal. It provides about 30% of the world’s energy, and is used in the production of 70% of the world’s steel.

Large global demand combined with slashed stock prices caught my attention.

Even though BTU’s stock chart was down-trending without any sustained sign of stabilizing, I began rationalizing. “This time, it’s different—it’s hit bottom—buy.”

I recognized this voice. It’s the same one that has drained thousands out of my account over the years. It’s the voice of impulsivity, wishful thinking, and greed.

But even though I recognized this voice, it was difficult to ignore. So, in an unusual moment of restraint, I did something new…

I visited the message board for BTU on Yahoo Finance. (This is a community board where investors like you and I can post our thoughts on a stock for public viewing.)

I wanted to look through the archives to see what investors had been saying about BTU over the last few years—as its stock had been imploding.

I thought that if I saw my own rationalizations for buying BTU—written in the past by investors who had gone on to lose money in the stock—it would help me realize I was about to make a huge investing mistake.

What I found was sobering…

What Wealth Destruction Looks Like

In late March 2011, Peabody Energy’s stock traded for more than $72 per share. Then, it began slipping…

One year later, the stock was down more than 53%. On Friday, March 16, 2012, it closed at $33.25.

This was one of the world’s finest coal companies. Its stock price had halved in one year… Was it a buying opportunity? It appeared so.

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But investors who bought in at $33 wouldn’t see their investments rise.

Over the next year, BTU continued to decline. On August 9, 2013, it closed at $17.90. Anyone who bought in March 2012—thinking BTU had bottomed at $33—was down 46%.

(If you had been in from the March 2011 high, you were down 75%.)

To many investors, it appeared to be an amazing buying opportunity.

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But over the next 21 months, BTU’s stock would see its value gutted another 79% from its August 2013 price.

On May 19, 2015, it closed at $3.76.

New investors called the bottom. I couldn’t blame them. I was watching the stock closely at this point. “How low can it go?” I thought.

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The comment above says: “Capitulation just happened.” For anyone who’s unaware, “capitulation” refers to that last gasp of life when the final few investors give up on a stock, sell in an effort to salvage whatever they can, and move their money into a less risky investment.

The idea is that once capitulation happens, a stock has truly bottomed out—offering huge bargains for fresh investors.

But BTU didn’t capitulate on May 19.

As I write, BTU trades for $2.09. That means BTU has dropped another 44% since its “capitulation” just a month and a half ago.

Based on its March 25, 2011, price of $73.60, BTU has lost 97% of its value.

Editor’s Note: Shares of Peabody Energy (BTU) have fallen 21.5% to $1.72 as we go to press. This happened after the coal mining company warned it expects to report even lower earnings in the second quarter…

The chart below tracks BTU’s fall, drawing attention to the times when the message board investors tried to pick the bottom.

Peabody Energy Corporation (BTU)

How to Protect Yourself

Looking at this train wreck in hindsight, it’s too easy to believe you would have known better…

But had I been paying attention to BTU three years ago, I might have been the one posting hopeful words on the message board… while my portfolio imploded.

Now, knowing that most of us have this tendency to make horrible investment decisions, how do we protect ourselves?

Two ways…

First, always use a stop loss. This is one leg of our Three-Legged Stool of Safety.

If you had owned BTU in March 2011 and followed a standard 25% stop loss, you would have sold your shares at about $54. ($72 x 75% = $54)

Based on current prices, that would have saved your remaining capital from another 96% loss in value.

The second way to protect yourself is by never trying to “time the bottom.”

When a stock is in an obvious downtrend, just wait.

Don’t buy until you see a sustained pattern of new, higher highs followed by new, higher lows. You’ll want to see this happening consistently for at least three to four months—if not longer—before you invest.

While this might mean you miss some early gains off the real bottom, it’s worth it.

Far better to miss a few points of upside than to be seduced into a false bottom… only to watch your investment plunge 44% in a month and a half.

The rules are there for your safety, friends. Please follow them.

Here’s to hoping that none of us ever end up on the Yahoo Finance message board, posting something like this…

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