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Editor's note: Today, we're sharing one last essential trading lesson. Whether you're already an experienced trader... or a novice just beginning to put money in the market... you'll find this timeless advice from Jeff Clark incredibly useful...

How I Allocate My Own Money

By Jeff Clark
Friday, May 24, 2013

Most traders are conservative with their money.
That statement flies in the face of the Hollywood image of stock-market junkies... Those gamblers are always screaming at the top of their lungs on the trading floor and waving their order slips, alternating between shots of whiskey and gulps of Pepto Bismol.
Yes, there are days when that Hollywood image rings true. There are days when traders have to be aggressive. For the most part, though, the smart traders are conservative.
My own portfolio, for example, is quite simple...
For my personal portfolio, I take 85%-90% of my investable cash and seek out low-risk, value investments – where there's not much risk, or the risk is at least hedged, and I can still earn a decent return. Then I take the other 10%-15% and use it to trade options, and try to add a little extra "pop" to an otherwise conservative portfolio.
The idea here is to earn enough on the conservative part of the portfolio to completely fund the option trades.
If I have a bad year trading options, my other investments make up for it, and I don't lose any ground. On the other hand, if I do well with the option side of my portfolio, it supercharges my total return for the year.
I don't care about how good or bad the broad stock market is doing. And I don't get caught up in trying to chase returns or worrying that I'm missing out on big gains by not owning the hottest stocks on the street.
All I want to do is earn a decent amount on my money and end each year in the plus column.
I first wrote about one version of this strategy back in May 2008 – just before the stock market cratered. While most investors lost money back then, 2008 was the best year of my trading career. I didn't take on crazy risks to do that. I simply stuck with my strategy of keeping 85%-90% of my money in conservative investments and risking up to 15% in option trades.
Here are a few other rules I follow...
Be willing to hold cash: You don't have to be 100% invested all the time. In fact, you shouldn't be. When there aren't many low-risk, value investments available, sit in cash and be patient. You will get a chance to put that cash to work.
Right now, after such a strong, one-way move higher in the market, there aren't many value areas in which to invest. My own account is nearly 80% in cash at the moment. And yes, I'll admit I've missed out completely on the last 80-point gain in the S&P 500. But my focus is on avoiding risk. I'm not trying to make as much as possible. I'm trying to avoid losing. So I don't mind sitting on the sidelines when things look a bit frothy – as they do right now. I'll put the money to work when we get a pullback and some of the air comes out of the risk bubble.
Be a contrarian: Buying "out of favor" stocks is far easier said than done. It is human nature to want to own what everyone else is talking about at the cocktail parties. But it's more profitable to buy the stuff they laugh at. The bargains are in the stock market's "humor section."
Right now, it's hard to find a more contrarian trade than the gold stocks. They're cheap and they're unloved. I'm nibbling on the mining stocks right now. In fact, of the 20% or so of my account that is invested currently, most of that is in mining stocks. And I've been collecting a nice income off of them by selling covered calls.
NEVER buy stocks on margin: Borrowing money to buy stocks is stupid. Yes, it can feel smart for a little while when the market is moving up. Eventually, though, debt will wipe out your account.
I'm not talking about the type of debt traders sometimes use as a convenience, since they have the money to back it up if necessary. I'm talking about the debt that leverages your account and allows you to be more than 100% invested. That sort of debt will always come back to harm you – often right at the absolute bottom of the stock market – when your brokerage firm starts liquidating your account in order to cover the debt.
Be willing to venture outside of the stock market, if that's where the opportunities are: A few years ago, when the municipal bond market got slammed on bankruptcy fears, I followed the advice of my friend and fellow S&A analyst Doc Eifrig and bought municipal bonds at significant discounts to par value.
I was able to lock in a nearly 6% annual tax-free yield, and I earned about 20% in capital gains as the muni-bond market recovered. A 6% yield may not sound all that sexy. But it was tax-free and low-risk.
Successful traders aren't gamblers, and we don't take on a lot of risk. We like to be liquid, so we do move in and out of positions frequently. That's what makes us "traders." For the most part, though, we're quite a conservative bunch. We have to be... especially if we plan on sticking around a while.
Best regards and good trading,
Jeff Clark

Further Reading:

This week, we gathered some of our favorite trading-education pieces from our top analysts. These are timeless lessons on how to safely profit in the market... and get the most out of your trading dollars. Find them all here:

In The Daily Crux
Market Notes
Utilities break down... sector fund XLU hits a two-month low.
Palladium prices are avoiding the precious-metals downtrend... up 11% in six months as gold and silver prices fall 20%-plus.
Big coal producer fund KOL sinks to a fresh four-year low.
Aerospace giant Boeing surges to a new five-year high.
Market Watch
Symbol Price
S&P 500 1649.98 -0.3% +25.1%
Oil (USO) 33.20 -0.8% -2.6%
Gold (GLD) 134.13 +1.7% -11.5%
Silver (SLV) 21.68 +0.8% -19.9%
U.S. Dollar 83.71 -0.7% +2.1%
Euro 1.29 +0.3% +2.6%
Volatility (^VIX) 14.19 +2.7% -36.5%
Gold Stocks (^HUI) 259.02 +0.9% -38.6%
10-Year Yield 2.03 +0.0% +18.0%

World ETFs
Symbol Price
Japan (EWJ) 11.42 -5.9% +31.0%
USA (SPY) 165.30 -0.4% +27.8%
India (IFN) 21.18 -1.5% +26.3%
Singapore (EWS) 14.12 -1.0% +24.8%
Israel (ISL) 14.24 -2.2% +18.3%
Taiwan (EWT) 13.83 -1.6% +17.0%
China (FXI) 37.02 -1.4% +14.4%
Canada (EWC) 28.00 -0.3% +11.2%
Russia (TRF) 14.81 -1.7% +11.9%
S. Korea (EWY) 57.42 -0.8% +10.5%
Lat.America (ILF) 42.05 -0.4% +7.9%
S. Africa (EZA) 62.09 -0.3% +3.0%

Sector ETFs
Symbol Price
Construction (PKB) 20.70 +0.5% +60.3%
Media (PBS) 20.66 -0.2% +47.8%
Financials (IYF) 72.55 -0.8% +38.7%
Health Care (IYH) 103.18 -0.1% +39.1%
Biotech (PBE) 29.60 +0.3% +36.2%
Consumer Svcs (IYC) 103.84 -0.2% +34.2%
Defense (PPA) 24.56 +0.3% +35.2%
Telecom (IYZ) 26.90 +0.1% +31.9%
Alt. Energy (PBW) 5.40 -0.6% +30.0%
Water (PHO) 23.06 +0.0% +30.8%
Industrials (IYJ) 85.20 -0.3% +29.4%
Transportation (IYT) 114.10 -0.3% +27.3%
Retail (PMR) 30.56 +0.1% +26.4%
Real Estate (IYR) 72.67 -1.4% +22.8%
Big Tech (QQQQ) 73.43 -0.3% +18.9%
Insurance (PIC) 19.01 +0.1% +18.3%
Basic Mat (IYM) 71.95 -0.5% +15.7%
Nanotech (PXN) 6.83 +0.4% +15.9%
Software (PSJ) 29.86 +0.5% +15.2%
Utilities (XLU) 39.15 -0.9% +14.7%
Semis (PSI) 15.70 -0.8% +10.6%

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