Last week I wrote, "I don't think a buy and hold strategy is the complete answer to mitigating risk." This statement was made in light of the data which showed that the holding period, i.e., time, is a major factor in generating profits in the stock market. While I do believe the holding period is an important factor in turning profits, (VectorVest has demonstrated it hundreds of times in our performance tests of high VST stocks), there's a lot more to managing a portfolio than simply waiting for it to go up.

The first thing one should do when building a solid stock portfolio is pick the right stocks. Although this sounds trite, it's something that must be done. Stock selection is covered in Chapter 12 of my book, "Stocks, Strategies and Common Sense." Simply put, one should start out by selecting safe, undervalued stocks that are rising in price. Pick a variety of high Relative Value, high Relative Safety stocks with steadily rising prices. Review my essay of 08/04/06, Shopping for Bargains. Study the graphs of high RS stocks and look at the phenomenal earnings performance these companies have had. Exemplary earnings performance is the key to picking long-term winners.

So, when would you sell one of these guys? There are two things I watch very carefully. First, of course, is price performance. If a stock's price starts to fall while the market is going up, something is going wrong and it's probably earnings. So EPS is the second thing to watch. Unfortunately, it is not easy to spot an earnings problem ahead of time. Take Chico Fas, CHS, for example. Its price peaked at $48.90 on February 21, 2006, then it started going down. Was there a problem? Its EPS graph looked a little shaky, but the stock's price was doing fine. When Chico's price dropped $6.40 a share on six times normal volume on March 2nd, however, it was time to consider selling the stock. It closed at $17.95 yesterday and its graph of EPS and GRT shows the reason why.

VectorVest puts a Stop-Price on every stock and it shouldn't be ignored. Take Enron, for example. Its price peaked at around $90 late in 2000, then bounced up and down for several months. It finally broke below its Stop-Price of $68.20 in the Spring of 2001, got an "S" rating, and made its final descent. Its financial data looked terrific, but it kept going down and getting more sell signals as the months went by. The bad news finally started coming out at about $20 a share. There was still time to get out with something, but, as you know, a lot of people didn't. The company, which had won all kinds of praise from Wall Street Wizards, went bankrupt and its price fell essentially to zero.

This is why you never want to dollar average while a stock's price is going down. And please, diversify your holdings, even if it's company stock. Many years ago I suggested to a Microsoft employee that he put at least a third of his fortune into Treasury bonds. He has thanked me profusely since then.

The buy and hold philosophy has many, many advocates and it has a wonderful ring to it. But it's a risky strategy unless you start out with good stocks. Therefore, risk management, knowing when to sell, diversification and asset allocation are equally important. Patience is a key ingredient to making money in the long-term, and I wish I had more of it. Combine good stocks, risk management and patience and you'll make profits.

Next week, I'll write more on Risk, Patience and Reward II.