I’m not really a New Year’s resolution kind of person, more of an “in all things moderation… including moderation” person…
BUT, if you’re someone using the new year to introduce or reinforce some disciplines into your life…. Be it exercise, diet, career….. I’d ask that you make room for one or two additional resolutions.
Let me explain.
December in Hong Kong is a busy month in the social calendar. And it’s a great opportunity to catch up with former colleagues and friends, business acquaintances and people in the finance industry.
People know I write The Churchouse Letter so invariably conversations turn to investing.
Now, everybody is ALWAYS happy to talk about their winning trades. The “biotech ETF that’s up 30% in 9 months”… or the genius call they made buying Apple.
Not only that, they’d tell me how they’d “cashed out”* and taken profit.
*Note: the only other time I hear the expression “cash out” is an hour’s ferry ride away in Macau’s casinos!
But I’m more interested in the trades that DIDN’T pan out. The losers. The ones that make you sigh and shake your head.
Here’s the thing… every single person I spoke to had at least one ‘war story’ stock…. the kind that were down AT LEAST 40 to 50%… and many were still in their portfolio!
Some rode losses all the way down to near zero. Not necessarily in 2014, but in prior years.
Let me be clear. The people I’m talking to in many cases weren’t just regular professionals (lawyers….doctors), they were finance professionals!
They run equity sales desks, bond trading teams… even hedge funds for goodness sakes! (One gentleman who runs a very successful hedge fund, rode a personal position in South American oil credit all the way down to the bottom…don’t ask!)
So what do we have? We have a group of professionally smart and successful individual investors who are holding on to their losers, and selling their winners.
Take a step back for a second and look at that rationally.
Cut winners. Ride losers.
How profitable is that in that long run do you think? It ain’t. In fact it’s guaranteed to lose you money.
So let me ask you some questions:
- Do you get a horrible sense of dread when you think about the losing positions in your portfolio?
- Do you grimace on the rare occasion that you gather enough courage to check on them?
- Do you think to yourself “Well it’s down 50%… there’s no point selling now… it might go back up”..?
- Or do you just completely ignore them and focus on the winners?
If you experience any of the above… you’re not alone.
But there’s an unbelievably simple ‘resolution’ to this (pun 100% intended).
It’s a simple investment discipline that lets you ride the winners and cut the losses.
I’m talking about stop losses.
Yes, I know many readers will be familiar with this.
But I’m writing this email because not a single individual investor I spoke to last month was using this strategy.
So there’s every chance that my readers won’t be doing this either.
What is a stop loss? Simple. There are two kinds. Trailing stop losses, and hard stop losses.
A hard stop loss is straightforward. It’s a specific pre-determined exit price for your investment. It never moves.
Let’s say you buy a stock for US$100 and your hard stop is -20%.
If the price of the stock ever closes lower than 20% below your entry price (US$100), you sell.
A trailing stop loss takes the same principal, but instead of calculating the stop price as 20% below your entry point, you calculate it as 20% below the maximum price achieved after you purchased the stock.
Your stop price moves over time.
Same example, you buy the stock for US$100. A couple years later it goes to US$200 and then starts to fall.
The maximum price since you purchased the stock is US$200. Your stop loss is 20% less than that… US$160.
If the stock closes below US$160, you sell.
It’s that easy.
What does this strategy do?
- It lets me ride my winners,
- It lets me ‘lock in’ profits on great performers that start to slide,
- It lets me cut losses with zero emotion, and..
- Over time, it fills up my portfolio with great performing stocks.
Stop losses are one of the only times in investing where I believe “act now, think later” applies.
Why? Because let’s say you have a great stock in your portfolio. It’s a classic blue chip. You’ve held it for years. And for whatever reason a stop loss is triggered.
Maybe you want to hold on? And why not? It’s a great company. It’s been around for decades. It has an outstanding dividend track record.
Here’s why you sell. You may or may not know WHY the stock is down.
Maybe the market is telling you the stock needs to get cheaper for reasons you don’t know about yet. It’s not in the news.
Hitting our stop means we either preserve gains or limit losses, and we can take a breather…. Reassess our view on the company.
“Act now, think later.”
Readers of The Churchouse Letter will know we hit our very first stop last month. The company in question is just like the one I mentioned above… it’s a top drawer Asian blue chip. BUT, it has a lot of exposure to both the Eurozone and oil prices, hence the recent underperformance.
I love the company long term, but we maintain our stop loss discipline.
We can buy the stock again after we’ve reassessed it which is in itself another great reason to act on stops… it forces us to re-examine our view on a company.
And don’t forget, a stop loss is not the only reason we exit a trade. It’s just a profit-maximising, loss-minimising tool for our investment toolbox.
So if you have some resolutions for this year, I hope you consider making stop losses a part of your investment discipline. Even if you don’t subscribe to The Churchouse Letter (where we have a stop loss on every position), I would urge you to think about applying it.
Maybe there are examples in your portfolio right now where a stop loss would have done you a world of good….
Good investing, and a Happy New Year!
P.S. Best of luck with the New Years Resolutions!
|Peter Churchouse is a widely respected analyst and commentator on financial markets with well over 3 decades residing in Asia. He spent over 15 years as Asia Strategist and Head of Research for Morgan Stanley as well as running a hedge fund. He shares his knowledge, insight and investment recommendations through his subscription publication The Churchouse Letter, along with his free newsletter Peter’s Perspective.|