If you follow me on the Tweetster and / or have read my Blog about Stoplosses - www.wheeliedealer.weebly.com/blog/to-stoploss-or-not-to-stoploss-that-is-the-question - and seen some of my other comments in Blogs, you will realise that I have a major Mental Internal Battle with regard to Stoplosses. In essence, I can see their appeal as Logic tells me they can avoid Big Losses, and probably the Best Investor / Trader I know, Robbie Burns (www.nakedtrader.co.uk) uses them religiously. However, when I try to use them, I just end up taking lots of silly small losses and days of Quality Research is binned because I am out of a Great Stock………and you can guarantee that just after Stopping me out, the Share Price rockets up and I would have made a packet !!
…..and to compound my Frustration and Mental Anguish, the Stock I moved the Cash into no doubt goes down !!
So, a compromise between these conflicting concerns is a trick I have used occasionally when I have bought a Stock that comes out with a Profit Warning and tanks. The idea of Normal Stoplosses is to help avoid the problem of holding onto ‘Losers’ as they keep going down. Momentum tends to be very strong - both on the Upside and the Downside - so a Stock that has put out a First Profit Warning will nearly always get itself into a Downtrend Channel that just keeps on going down.
If you think about it, it makes sense - the Stock puts out a Warning, then the Shares start to fall, but many Holders think “oh, it’s dropped a lot, but I am not panicking and selling out now, I will wait for a Bounce.” Then the Bounce comes and they sell, and this tends to be a concerted event and lots of Holders sell on the Bounce - so this drives the Price down again. This is repeated and the Share just keeps on going downwards.
The Beautiful Logic of a Stoploss is that after a certain Percentage (say, 10%, 15%, 20% or whatever), you Sell out of the Stock for a pre-determined, acceptable, Loss and this then gets you out of this horrible Downtrend Momentum that often occurs. Simply in these terms they really do make a lot of good rational, logical, sense.
As an aside, I know that many people will buy Stocks after the First Profit Warning - as they say it gives them the chance to buy into a Good Stock at an advantageous Price. Generally, this is not for me. I am a bit old fashioned and I still believe in the Medieval Adage that “Profit Warnings come in Threes” - and I think it nearly always holds true and it is just not worth the risk of getting involved in Stocks that have problems - unless you think after much rational analysis that they are only temporary - but this is rarely the case and I would contend that such Buys are very Risky.
Where was I? Oh yeah, so I am holding a Stock that is overall a good Business, but it has put out a Warning (or an Adverse News Event) that will whack it for some time most probably. If I had the Psychological Strength, I should just dump it and move on to the next Stock, but in practice I find this very hard to do - unless something has so fundamentally changed that the Company is in very real danger of going Bust or needing an Emergency Rights Issue or Placing which will massively dilute existing Shareholders - in which case I am not so bad at hitting the Sell Button and getting out.
From experience, I have generally found that the kind of Quality Stocks I try to Invest in rarely suffer permanently from having Profit Warnings - they may struggle for a year or 2, but they very rarely go Bust or need to issue New Shares in a way that screws over Existing Shareholders. If there is a Rights Issue, it is often at a good Discount to the Market Price and does not Dilute Existing Shareholders too much - especially if they take up their Rights and Buy the New Shares that are issued.
This is very different if you are in the Market for High Risk ‘kak’ like you might find in the WheelieBin (please see my Sister Website, WD2, at www.wheeliedealer2.weebly.com), where Rights Issues (and ’Placings’ that only Institutional Investors can participate in) can wipe out Existing Shareholders and leave them with a tiny fraction of their Initial Stake - that’s assuming they don’t actually go bust - which often happens. On these kind of High Risk Stocks - Percentage Stoplosses are a very good idea. I also think that Stoplosses are perhaps worthwhile for people who do not really do a huge amount of Analysis or just copy other peoples trades, without really Doing Their Own Research……
So, back to the flow, the Stock I hold has just done a Warning and it seems likely that the Stock may do nothing at Best and, at Worst, may go a lot lower, especially if 2nd and 3rd Profit Warnings come along. Obviously there are several Options with regard to what I could do now:
There may be other Options, but those are the usual ones. So, taking each one in turn:
1. Do Nothing - this runs the Risk of further problems and the Shares getting into a Momentum Downtrend - this will be frustrating, expensive and time wasting as the Money is ‘dead’ for a long period and not ‘working for me’.
2. Buying more and Averaging Down is extremely Risky - yes, it can sometimes (rarely) work well and add to gains nicely, but most often it means you just lose more Money and more Money is tied up doing nothing for you (please see my Blog www.wheeliedealer.weebly.com/blog/is-averaging-down-the-root-of-all-evil)
3. Sell out of the Stock entirely and move on. This might be the best approach, but I find this very hard to do and I know many other Investors feel the same. This course of Action means you will take a Real Loss as opposed to a Temporary ‘Paper Loss’ but it might actually be far better - your remaining Dosh after taking the hit is rolled into something else - logically it really appeals to me, in practice I totally struggle (please see my earlier Stoploss Blog with the Link at the Top of this Blog).
4. Sell Half or part of the Stock Position - well, this is what this Blog is about - finally got there - thank you Readers for being so patient…... Because I see the advantages of Action 3 but I struggle with it psychologically and find it is hard to use in practice, selling Half of my Position is a very good compromise. This method scores because you hugely reduce your Exposure to the Stock in case any further Problems arise or it continues in the Momentum Downtrend, and it feels great Psychologically because you feel you have actually taken Decisive Action and done something rather than just continually watching the Price drift lower and worrying. The second part of this method is to Buy more Stock again when the Problems are clearly over. This may take years to happen, but while you are waiting you have much less Exposure to it and Money tied up and it means that you are very close to the Stock in terms of understanding the Business - after all, you did thorough Research in the first place and you have been worrying so much about it that you know the Business better than the Directors do !! The extra advantage here is that because you are monitoring the Company’s progress closely, you can spot the optimum time to Buy back in and you get the Shares Very Cheap and Low because the Market has not yet cottoned on that things are improving - this can be very lucrative and I have done it a lot. However, you must be very careful - if you Buy back in too early, you could just be putting more Money into the Downtrend. The Trick is to watch the Company’s Progress but also monitor what is happening with the Price Chart. In simple terms, draw the Downtrend Channel Lines in neatly and watch for the Price to ‘Breakout’ of the Downtrend and start moving Sideways - this is the first sign that things are on the mend. Occasionally, but rarely, the Price will start to move into a Shallow Uptrend Channel just after the Breakout - watch for this and get ready to Buy back in. More often, the Price will go into a Sideways Channel and you can draw in the Trendlines so you are ready to spot when it ‘Breaks-out’ and moves into an Uptrend - you want to Buy in at this point.
Slight deviation - you know I said about how Momentum is a Powerful force? Well, to cheer you devout Readers up, apart from Downward Momentum being very Powerful at losing you money, Upward Momentum can be extremely Powerful at making you money as well. If you can get into a Stock with Strong Upward Momentum, it is best to hold on as long as you can or maybe just TopSlice (TopChop) if you feel you should take some Profit - the Momentum can keep the Stock going up for a lot Longer than it probably should do according to Valuation and stuff - you want to take advantage of this if you can - it is one of the rare ‘Free Lunches’ in Investing / Trading.
Sell Half on a Profit Warning - a Real Life Example
I bought into Lamprell (LAM) at around 285p back in January 2012 and the Price carried on Upwards, so I added to the Position with a Spreadbet at about 310p shortly afterwards. All was going well and then all of a sudden, there was a Profit Warning and the Shares just fell of a Cliff. This happened in about May 2012 and the Shares dropped to as low as about 55p - which was well nasty.
Looking at these numbers now, I realise this really was a Nose Dive and I remember being very concerned that the Company could go Bust - it did seem like it had badly gone off the Rails. I think this was around wider problems with Greece and the Eurozone Economy and Markets were very unforgiving. The essence of the Problem was that LAM make huge Oil Rigs and they are big one-off Projects which are very ‘lumpy’ with regard to Order Visibility - and all you need is a problem with one Rig Build and it can cause all sorts of Financial Issues for the Company. I recall LAM went from a healthy Balance Sheet to having a large Debt - it was pretty touch and go really - Bankruptcy was a real possibility.
LAM had taken over another Company based out in Saudi Arabia and the Project Management was obviously very poor and there were awful delays and dissatisfied Customers. I was very worried but could not bring myself to Sell my Stake as I felt there was something good underneath all the problems - although it was a big Risk.
Anyway, what I did was to Close my Spreadbet and take the Loss at 70p (ouch - that is about 240p of Loss per Share) but it now meant my Risk was pretty small. Luckily, what then happened was that New Management were brought in with a New Chairman and New CEO and they got a grip on the useless Project Management and started to turn the Business around again. I then took advantage of a Rights Issue at 77p in June 2014 which meant I bought a lot more Shares when the Market Price was actually 145p. The Price is now about 149p and it is all working out nicely and I expect a lot more Upside to come as the Company seems to be on the mend and is in a nice Uptrend.
I still feel this is quite a Risky Business because of its Order ‘lumpiness’ and the uncertainties around the Oil Price - so I have not as yet added a Leveraged Spreadbet - leverage can be very Dangerous on High Risk Shares as this example will have already demonstrated !! In addition, I am not tempted to buy more Shares either - I am happy with the Stake I have now and over time I expect to recover any of the losses I had to take after the initial Cliff Dive.
An Adaptation to a Conventional Stoploss
As usual with my ‘method’ for scribbling Blogs, I bashed out a fair Draft of this one a few days ago and over the following days I thought about how this could be used for an Adaptation to the usual % Stoploss Approach.
I have never tried this, but my thinking is that for someone like me who struggles with the usual “Sell whole Position once Share Price falls 20%” or whatever the Rule is, a fudge would be to Sell Half the Position if the Price was to fall and hit the Stoploss Level. In a way, this could be a superb compromise - it would mean that the Stock’s impact on the Overall Portfolio would be dramatically reduced if it was to get into a Downtrend because it would now be a much smaller Weighting, but would have the added advantage that it would mean I was still in the Game with a Stock that I had researched in depth before my Buying Decision.
As described earlier in this Blog, if and when the Stock / Company proves that things are going ok, then I could Buy more of the Stock again once I am confident it is on the Up.
It’s an interesting concept and something I must think over during these delightful Summer Months out in the Sunshine !!
Not sure why I just put that title in as this will be pretty short. In essence, if you can’t muster up the Moral Fortitude to do a Stoploss and dump the Stock, then maybe just Selling Half of your Position (or Part of your Position) is a reasonable compromise. You can do this after a Profit Warning or if there are other News Events swirling around the Company that have caused a Drop in the Share Price and worries over further problems.
This ‘Sell Half’ idea could be used with a Conventional Percentage Triggered Stoploss.
The Counterpart to this Approach is that you must Buy Back in later when things are sorted and improving - this gets you the opportunity to Average Down and take advantage of the Low Price.
In effect, it’s just another Tool in the Armoury, and I hope this has given Readers something to think about particularly as I know many of us have been hit by Profit Warnings this year - I won’t name names much as I don’t want to cause Flashbacks and visits to Psychiatric Wards, but I myself have been whacked by SAL, SGI and TEP among others……….
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