To stop stock loss, neither a gambler nor a holder-on be

To stop stock loss, neither a gambler nor a holder-on be

MARCUS PADLEY
July 3, 2010

I RECENTLY wrote an article declaring that the biggest mistake a private investor can make is not selling. Since then I have been bombarded with questions about my own stop-loss selling strategy. So I'll tell you.

But before I do, you should know that I am possibly a little different to most of you. I have learnt to sell as easily as I buy. I am regularly in 100 per cent cash. I don't need to be in the sharemarket.

I don't need the sharemarket for a dividend income and I long ago got over the philosophy that you hold stocks forever - utopian crap - and that you can't time the market - a lazy professional's excuse for doing nick all for his money.

So, with that disclaimer, here are a few of my stop-loss strategies that you might consider for yourself.

THE HOLIDAY STOP-LOSS

I sell everything before I go on holiday. I once ruined a holiday by fretting about some dumb stock position when I should have been chasing my wife and kids around. Never again. Of course, I'm not suggesting you do that. It's just that when you have your head in the sharemarket all day every day, a holiday isn't a holiday unless you get it out.

THE INSOMNIA STOP-LOSS

I sell anything that could possibly keep me awake tonight. Sorry, but I reckon it's really dumb to be worrying about what Wall Street's going to do overnight. Let's face it. If that's your concern, then you are gambling, not investing. Utter luck is a cruel mistress and if that's what you are relying on, you have gone astray. Unless, of course, you use the sharemarket to gamble, for creating a rush. That's fine. But don't dress it up as anything clever. There's nothing clever about going to bed with your fingers crossed.

THE ANXIOUS STOP-LOSS

I sell anything that is disturbing me. I put a high value on my frame of mind. With only 252,522 days left to live, of course you can't really afford to waste any time being miserable, especially not about money, which ultimately, is all that stocks represent. Biting the heads off the kids or blowing your window of opportunity with the missus because of some dodgy stock is about as stupid as it gets. Those windows are pretty small. So if in doubt, get out.

THE OBJECTIVITY STOP-LOSS

I used to operate a stop-loss that triggered when a loss was so big I felt I wouldn't be able to tell Emma. But when I confronted her with one once it turned out she had a bigger risk appetite than I did. Embarrassing as it is, my wife has the bigger kahunas. I bottle it before she does. So that little system has become redundant. But for you, it may not be. If in doubt, discuss it with someone. When things are about as bad as they can get, you need objectivity, which means you need to talk to someone. Use someone else as your stop-loss.

THE PUNCHING THE AIR STOP-LOSS

I sell anything that provokes me to stand up at my desk and punch the air in delight. As any stockbroker will tell you, euphoria means ''Sell''. It has exceeded your expectations and asking for more is simply greed. You have to book the wins some time. This is as good a moment as any.

THE DENIAL STOP-LOSS

I sell anything I get wrong. Stocks analysis is not a science. You cannot pin down certainty. And there are so many variables and so much sentiment that getting it wrong is to be expected, is inevitable, and when you do get it wrong you have to act, not deny. There is no room for pride in stock decisions. Advisers telling clients not to sell because they couldn't admit they got things wrong in the financial crisis (pride and denial) cost billions of dollars and thousands of client relationships. We all get things wrong. Accept that and half the game - not losing money - is won.

THE SCHOOL FEES STOP-LOSS

Paying essential bills takes priority over trading, I'm afraid.

THE DIVORCE STOP-LOSS

Only triggered it once and if you can exercise the ''engagement ring thrown at you'' stop-loss effectively you'll never actually need it.

I could go on.

Marcus Padley is a stockbroker with Patersons Securities and author of the daily sharemarket newsletter Marcus Today. For a free trial, go to marcustoday.com.au

Source: The Age


Comment:  
On the other hand, there is a person I know who "lost" money each time he sold, as his sold stocks continue to go higher subsequently.

3 Questions to Ask Yourself When Buying a Stock

3 Questions to Ask Yourself When Buying a Stock

May.03, 2010

Trading in the stock market can be a very emotional experience. It can be hard to focus on logic and actually make rash decisions when your money is on the line. That is why, whenever you are thinking about investing into a stock you should ask yourself these three questions.

1. Why Am I Getting Into This Stock


Why are you actually getting into the stock? Is it because you heard somewhere that it is going to go up and you didn’t want to “miss out”? Or you have some fundamental or technical reason for getting into the stock. Unless there is something solid backing your decision it may be better to just walk away.

2. How Am I Going to Limit My Risk


Even if you have found a stock which you believe with 100% confidence will make you money, you may be wrong. Something may change. It happens, a lot of successful traders invest into bad stocks the trick is limiting your losses.

Maybe you want to only risk a small portion of your account on that one stock, or maybe you want to place some sort of stop to get you out of the position if the stock falls against you too much. Either way, it is important to limit your risk; otherwise you will lose all of your money on the first bad trade you make.

3. When Will I Get Out?


Something that people often forget is their exit strategy. Sure it is important to know when to enter, but even the best entry signal in the world will not help you out that much if you lose it all by holding onto the stock for too long. Figure out what you are trying to accomplish beforehand.

Stock Market Strategy For Big Profits

Stock Market Strategy For Big Profits

by Gary E Kerkow

Article Source: www.linkroll.com - Stock Market Strategy For Big Profits

Buying the best growth stocks at the right time certainly can make you decent money in the stock market. If you want to make really big profits, adding to a winning position at the right time can achieve this for you.

First, if you have any losing stocks, sell them. This will give you extra cash to buy more shares of your best stocks at a proper strategic point.

Its always wise to only make new stock purchases or add shares to winning stocks when the general market direction is in a confirmed uptrend. This is because approximately 75% of all stocks follow the current general market direction.

Big institutional stock market participants such as mutual funds, pension funds and banks like to add shares to their winning stocks when they retreat back to their 50 day moving average line. This is usually done after the stock makes a solid price advance,then retreats to the 50 day line. You can use this same strategy with your best winning stocks. Just make sure your stock bounces off the 50 day line and starts advancing again. You don't want your stock to break below the 50 day line, especially on heavy volume.

Always remember to implement good money management when trading or investing. Cut your losses short and let your profits ride. That is the golden rule of trading. I suggest to never let your stock go down more than 10% from your original buying point. If you bought a stock at 40 dollars per share, you should set a stop loss at 36 dollars to protect your trading capital. You can always move the stop higher as the price of your stock advances.

Good strategies for buying in and for preventing big losses

Strategies for buying in:

• Lump sum investing
• Dollar cost averaging
• Phasing in

Strategies for preventing big losses:

• Stop loss strategy
• Rebalancing

Dollar cost averaging and phasing in strategies are useful for those who wish to reduce the risks associated with market timing. 

Regardless of the buying in strategies (lump sum, dollar cost averaging or phasing in), acquisitions should only be done when the stock is available at bargain price or fair price, and certainly never when it is overpriced.

Stop-loss maybe unnecessary for some or many investors if the other risk management ideas are followed.

Value investors with a long term investing time horizon rarely need to use stop loss strategy.   In fact, the drop in price offers an opportunity for the value investor to reduce his cost per share.  This is safe provided he has not made a mistake in his initial assessment of the quality, value and management (QVM) of the stock.

Rebalancing at regular or fixed intervals can be usefully employed to bring his equity portion to a previously determined set proportion of his asset allocations in his portfolio.  This is particularly useful for those who are unable to take big risks (big losses: real or missed profit losses) during the bear or bull markets.

Though theoretically attractive, to be able to profit through rebalancing, near the peak of the bull or near the depth of the bear market, assumes one has the ability to predict (time) the market consistently.  This is of course not possible.

Always keep in perspective the 3 personal factors that are very important in your investing:  time horizon, risk tolerance and investing objectives.

Two important strategies to help you avoid large losses: STOP LOSSES and REBALANCING

Stop losses and rebalancing are strategies to help you avoid large losses when you invest in equities.

Stop-loss strategy

A stop loss is a specified minimum price at which you will sell a particular share in order to stop the loss.  This is a good strategy with which to protect yourself against large capital losses.  You decide on a percentage loss that you are prepared to take on your investment, and sell when it reaches that percentage.  Stop losses are implemented when the buying of shares (normally not unit trusts) takes place, i.e. an instruction is given by the investor to the stockbroker to buy 1000 shares in XYZ at, say $10,00 and to implement a stop loss at, say $9,00 (the investor perceives XYZ to be a somewhat risky proposition).  The investor has done his sums and comes to the conclusion that the maximum loss he can bear is $1000, hence he limits his potential losses to $1000 by implementing a stop-loss strategy ($1000 divided by 1000 shares = $1.00 per share; $10.00 per share - $1.00 per share = a stop-loss level of $9.00)


Rebalancing

This strategy is best explained by an example.  Following the analysis of your investment profile (time horizon, risk tolerance, and investment objectives), you decide to invest 50% of an amount of $1000 in equities and 50% in other asset classes, such as bonds and cash.

Assume that after a year your equities have decreased to $400 and your other investmens have increased to $800.  This means your original $1000 portfolio is now worth $1200.

Rebalancing means that you adjust your portfolio constituents to get back to a point where half is again invested in equities and half in bonds and cash.  You will therefore have to sell some bonds and buy some equities.  This is an important strategy to keep your portfolio diversified and in line with your time horizon, risk appetite and investment objectives.

How Laura's loss was Glenn's gain

How Laura's loss was Glenn's gain


The stock began to climb. Last Friday, it looked like we had a clean shot at walking away with a 100%-plus gain.

But there was no announcement.

The company waited until Monday morning before market open to sneak out a release that the FDA had withheld approval. We sent out an alert to sell the stock for the best price our readers could get.

The stock opened dramatically lower: Instead of taking a triple-digit gain, we had to mark our closed positions portfolio with a 50% loss.

(The problem with a stop loss in this situation was the dramatic drop in the stock's valuation right off the bat! If a stock opens 60% below the previous trading day's close, your chances of selling at your 20% trailing stop are almost nil.)

http://investmentsthatwork.blogspot.com/2009/12/how-lauras-loss-was-glenns-gain.html

Pros and cons of using stop-losses

Here are two episodes to illustrate the pros and cons of using stop-losses:

Cons

"So, in December 2003, I invested in the company at an effective price of 90 cents, which implied a market capitalisation of about $220 million. Over the next six months the price had a strong trend - downwards. In July 2004, it fell to as low as 55 cents.

This was around the stop-loss level I had in mind when I invested.

There didn't seem to be any reason for the dramatic fall. Everything seemed to be going on track for the company. The network was being set up, trials of the system were progressing and the modems they had ordered were being delivered.

Here was a classic stop-loss dilemma. If I had thought that there was any way the price would drop so severely, I would not have invested. The fundamentals were sound, so if anything the company was a buy at this price, rather than a sell.

I held on to my investment. Since I had quite a large position, I didn't buy any more. Fortunately for me, the price recovered as the company achieved some success with its product launch in August 2004 following a strong advertising push. That sent the price to over $1.10. I later exited my position at around $1.00, when I became worried about potential competition emerging from other companies."

Pros

"I had a tough experience with my ARC shares, where cutting a deteriorating position would have been the better choice than hanging on, and where clearly I was stressed and lacked discipline - exactly the problems that a predetermined stop-loss strategy seeks to avoid. "


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In the first episode, the investor did not use a stop-loss, and the market recovered allowing him to salvage a small percentage profit. His confidence was rewarded.




Summary on stop-loses

Have a stop-loss in your mind when you invest and if the price hits the stop-loss level, always cut if:

• the loss is threatening to be destructive;
• you are confused about what is going on; or
• the fundamentals are moving against you.

You should only keep the position and consider increasing it if you remain genuinely confident about the underlying fundamentals. Experience will help you recognise when you are starting to rely on nothing but hope. If you do stay in, choose another stop-loss level as a reference point, and stay disciplined.

You should also manage risk by not betting too much on one idea and by anticipating market moves twice as big as seem reasonable.

The stop-loss dilemma

This technique enables an assessment of the potential cost if things go wrong. If the investors buy a stock at $100 with a stop-loss price of $75, they know in advance that their maximum loss is $25. There are also other variants which aim to limit the potential reversals of profitable positions. With a trailing stop-loss, the stop-loss price rises in line with the market price. So if the market rallies by $10 to $110, the stop-loss price might also rise by $10 to $85.

The benefits of a stop-loss

It forces an investor to be disciplined. When a position goes wrong, it can cause stress and cloud people's judgement. Anticipating this, and deciding on a stop-loss level in a calm and relaxed manner beforehand, can ensure that an investor will remain objective.

A stop-loss also allows a specific amount of capital to be allocated to each idea. So an investor might be prepared to lose say, $10,000 on a hunch, and say, $25,000 on a firm conviction.

The argument against stop-loss

It doesn't seem very scientific.

Is this necessary if the other risk management ideas are followed?

The choice to cut a losing position is a dilemma.

On the one hand, the positives for managing risk and preserving capital are clear.

On the other hand, if you are confident an investment is a good idea but the price moves against you, perhaps you should be buying more, or at least holding, rather than cutting.

How you may overcome this dilemma?

One discipline which you should use is to value your position regularly using the current market price. A losing position clearly means that something unexpected has happened.

When you invest, have a stop-loss in your mind. If your investment hits the stop-loss level, make a judgement on whether to cut, based on your confidence at the time about the position.

If the loss is threatening to be destructive to your finances, it is absolutely vital to cut. To be at this point, the price must have moved a really long way against you, if you have not bet too much on the idea in the first place.

You must also cut if you are confused about what is going on, or if the fundamentals are moving against you. In these situations, you see the prices go further than expected.

The decision not to cut

There are times not to cut a position, even if it reaches your stop-loss level. These are when two conditions are satisfied:

1. you have the capital in case of further losses;
2. you understand the reasons for the adverse price move, but remain confident that there will be a recovery.

Here it may make sense to hold the position and even to consider buying more. (It is sensible to see the market starting to recover before adding to a position.)

The decision to keep a losing position must not be based on emotion or on any sense of living in hope. You must admit to yourself that things have not gone the way you expected, and that since you have been wrong up to this point, you may well be wrong again. There is an old saying along the lines of 'the market can remain irrational much longer than you can remain solvent'.

Summary

Stopping out is the hardest transaction. No one likes to give up hope. But it is essential in some circumstances. Beginner investors should be especially cautious about mounting losses.

Sometimes you cut a position and then the market recovers. Don't be put off stop-losses by those experiences. The horrible feeling of cutting a position only to watch the price turn and recover is one of the worst for an investor. You are talking about probability and random events, and over time all sorts of good and bad things will happen. You have to look at the long term. Normally after cutting a bad position there is a strangely cleansing feeling - some people say it's a bit like getting out of a bad relationship!

Stop-loss maybe unnecessary for some or many investors if the other risk management ideas are followed.