Tomorrow marks the 35th anniversary of a dark day in stock market history.

On October 19, 1987, the U.S. stock market crashed. By the time trading was halted on “Black Monday,” the Dow Jones had lost 22.6% in a single day.

Millions of investors panicked. They sold whatever they could. But that was a mistake. They should have been buying instead…

You see, the market quickly recovered — and it soon set new highs.

In my opinion, one of the biggest mistakes investors make is using Wall Street’s standard “stop-loss” of 20%. Case in point: if Black Monday investors had doubled-down instead of getting stopped-out or panicking, they could have turned a paper loss into a tidy profit.

And this, my friends, is the idea behind my staggered-entry trading system…

I call it the “Cowboy Split.”

The name might sound funny. But this is no joke. In fact, this can be a way for you to consistently crush the overall market…

A Big Sale on Wall Street

I remember Black Monday like it happened yesterday.

And a conversation I had that day speaks volumes about my approach to investing, and my approach to beating the markets.

At the time, I was San Francisco bureau chief for American Banker, the bible of the industry.

My boss called me from New York to talk about the crash. “It’s kaboom,” he said.

“Kaboom?” I replied. “Not all all. Wall Street is having a big sale.”

Following Wall Street “Wisdom” Can Cost You Dearly

You see, armed with an honors degree in Economics, I’d spent countless hours researching market data, and then looking for ways to use crashes and selloffs to help individual investors.

My research showed that many of the stocks that got hammered in a daily session would quickly recover. And many went on to hand their investors big gains.

But if you got stopped-out in a selloff that was simply an overreaction to the headlines, you left a lot of money on the table. In other words, blindly following Wall Street’s “wisdom” about using stop-losses can cost you dearly.

That’s where my Cowboy Split comes into the picture. This is such a powerful tool that I use it for every trade I recommend.

Let me explain how it works…

Introducing: The Cowboy Split

The Cowboy Split involves making multiple (“split”) entries when acquiring shares of stock.

With this process, first we buy some, but not all, of our intended stake in a promising stock. For example, let’s say we buy half of our intended stake.

At the same time, we put in a “lowball” limit order to buy the remaining 50% if and when the market or the stock itself retreats by 20%.

To help you better understand this classic defensive move, let me walk you through an example of how it can add to your profits.

An Example

Let’s say you have your eyes on XYZ Tech Corp., and it’s selling at $25 a share. The company is in a hot growth sector, and it has great financials and a solid chart.

Let’s further assume that you’re interested in owning it for the long haul.

Well, in this scenario, you can use the Cowboy Split to buy on the dips — and therefore increase your overall profits.

Here’s how you do it:

To start, you invest half of your standard stock purchase at market — in this case, $25 a share. As soon as the market order fills, you enter what’s called a “lowball limit order.”

This means you tell your broker that you’d like to buy a second tranche of XYZ at a lower price. A 20% discount is a great rule of thumb for filling the second half of your Cowboy Split.

So you enter a “limit order” for the second round of XYZ at a price of $20 or lower. If the stock falls to that price, your order automatically fills, and now you have an average purchase price of $22.50.

Once the stock resumes its climb, you have extra profits baked-in. For instance, when XYZ hits $30 a share, your cumulative gains are now 33%. ($30 minus $22.50, divided by $22.50, equals 33.3%.)

If you’d simply bought the stock and held, your returns would have been just 20%. ($30 minus $25, divided by $25, equals 20%.)

In other words, the Cowboy Split increased your profits by more than 60%! (33 minus 20, divided by 20.)

Keep in mind (and this is crucial): if you hadn’t used this strategy, you’d have been stopped out at a loss! You’d have had a loss of $5 a share, or $500 for every 100 shares you bought.

Free Portfolio Insurance

Let me be clear about something:

This strategy doesn’t work every time. For example, sometimes you’ll still get stopped out.

But this greatly reduces the risk of that happening.

And by the way, if the stock doesn’t correct, and your lowball limit order never fills, that’s perfectly fine…

Sure, we didn’t increase our overall gains. But we got some portfolio insurance for free.

Turn Setbacks into Profits

As you can see, the Cowboy Split can be a powerful portfolio management tool. It’s a great way to play defense in the midst of a bear market.

And with this approach, you won’t get left on the sidelines when the uptrend resumes.

Which brings me to another key point:

The long-term bias of the stock market is up, toward making money.

Data compiled by Nobel Prize-winning economist Robert J. Shiller show that, since 1971, the S&P 500 has averaged annual gains of 7.6%, not counting dividends.

That’s amazing. Keep in mind this includes the tail-end of the Vietnam War, the stagflation of the 1970s, the dot-com bust of early 2000, the 2007 financial crisis, not to mention the 1987 stock market crash.

Now you can see why I keep reminding investors that you always want to have some money in the market.

And as you learned today, with the Cowboy Split, we can turn market setbacks into profits…

The kind of profits that build wealth over the long haul.

Cheers and Good Investing,

Chief Investment Officer
Trend Trader Daily

Tags: cowboy-split wall-street