The Odds Are Stacked Against You

Editor’s Note: This week, we’ve been talking a lot about the importance of nailing down an exit strategy.

Today, Matthew shares an example of how trailing stops could have saved investors a bundle of money.

And before you start thinking we’re beating a dead horse with all this talk about stops and exit strategies, remember this is one of the Club’s Pillars of Wealth.

We’ve proven that it’s an idea that can make or break a portfolio. In other words, it’s a subject worth immense discussion.

– Rachel Gearhart, Managing Editor

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The most important investment decision an investor has to make isn’t when to buy… It’s when to sell.

The No. 1 thing you have to know when buying shares of a company is your exit strategy. Revenue growth, earnings potential, possible new customers… all of these things are meaningless to you as an investor if they never materialize and you’re left holding shares of a company that’s losing value.

So before you ever press that “buy” button, you have to know when you’re going to hit “sell.”

That’s because – without knowing when to sell – investors will hold on to positions well beyond the point they should’ve sold them.

But let me remind you why using a wealth protection strategy like trailing stops or hard stops is so important… Because the more the price of a stock falls, the more herculean of an effort you’re requiring just to break even.

Let’s say you begin 2016 as a big believer in Concordia International (Nasdaq: CXRX). It seems like a great opportunity in branded and generic pharmaceuticals.

From October 2014 to September 2015, shares more than doubled.

But in September 2015, it announced an acquisition investors weren’t fond of. And this started a bloodbath as competitor Valeant Pharmaceuticals (NYSE: VRX) came under fire for price gouging – not only from short sellers, but also from Congress. The hostile atmosphere was bad news for Concordia. Its business is entirely U.S.-based, so it relies on drug price hikes.

Throw in a broad market collapse to close out September 2015, and Concordia’s share price was cut in half.

You did your reading and due diligence, and plenty of experts are claiming Concordia is a great buy. There are plenty of risks, but there is also the possibility that shares could surge from $39.58 to more than $84. After all, shares were $84 just a couple months prior.

Unfortunately, by the end of the first week of 2016, your Concordia investment is down 10%. That means, to get you back to even, it has to rise 11%. Frustrating, but doable.

Soon, your position in Concordia is down 20%. You wonder if you should sell. At this point, just to break even, your shares have to gain 25%.

There are some brief moments of relief. It looks like things are going to turn around, so you keep on holding. But then Brexit happens, and the Concordia shares you bought at $39.58 on January 1 are trading at $19.69 on June 27 – a loss of 50%.

At this point, you’re begging for your shares to double. And that’s not to book a gain. That’s just to make you whole again.

The more shares of an investment are allowed to lose, the bigger the gain required just to get back to even. You stack the odds against yourself by holding on to a declining stock as it goes lower and lower.

For example, shares of Concordia are trading at $3.83 today…

That’s means they’ve lost a little more than 90% of their value so far this year.

A 90% gain from this point won’t even be close to taking you back to breakeven. That would just mean shares of Concordia would be trading at $7.28. You’d still be down 82% on your original investment at $39.58.

If shares were to double or triple or quadruple… It wouldn’t matter. Your Concordia shares – just to get back to breakeven – have to gain 900%. And that’s to walk away without a loss.

How long is an investor supposed to wait for that to happen? A year? Two years? Five years? And that’s if Concordia shares ever come back.

Let me put it this way… Over the past five years, only 13 stocks have gained 900% or more. That’s only 13 out of the thousands of publicly traded companies.

More than three times that number have lost 90% or more of their value during the same span. And 13 stocks have lost 80% or more since the start of the year.

By using a trailing stop sell order when you place your buy order, you protect your gains, as well as prevent a loss from becoming devastating.

The Oxford Club recommends adhering to an exit strategy like a trailing stop so emotion never gets in the way of when you should sell a stock. It’s how The Oxford Communiqué escaped the 2008-2009 market crash with a total average return of 28% while others suffered significant losses.

Clearly the strategy works.

Good investing,

Matthew