This Safety Precaution Could Be Hurting Your Returns

From the Baltimore Clubhouse – This safety precaution could be hurting your returns…

Last week, we talked about the importance of rebalancing your portfolio. This satisfies the Club’s third Pillar of Wealth.

And today, we’re going to talk about our second Pillar: Know your exit strategy.

As you know, we’re constantly monitoring our mailbag. A recent question from Director’s Circle Member Bob C. really stood out. Since it’s so important, we’re dedicating an entire Insight article to it.

Here’s Bob’s question:

Rachel,

I’m very familiar with the normal 25% trailing stop approach for The Oxford Club, and I like it. But the editors for the premium subscriptions seem to use a different approach to stops, and it looks to be unique to each editor. Is there any way we could get some insight into the different approaches used by Marc, Matt, Alex, etc.?

Thanks,

Bob C.

Again, we dedicate one of our Four Pillars of Wealth to trailing stops. That’s because having a stop that’s too tight could cut into your profits. And having a stop that’s too loose could cost you your investment. Clearly, it’s an important topic.

So I reached out to the Club’s experts and asked them to explain their rationales for trailing stops that diverge from the Club’s traditional 25% policy.

According to Chief Investment Strategist Alexander Green, “If you run the stops looser, you can hold on to your positions longer and potentially make more. If you run your stops tighter, you may get knocked out of a position sooner but you can also protect more of your profit. I run tighter stops in my VIP portfolios because we are specifically trading for short-term profits there.”

And Chief Income Strategist Marc Lichtenfeld uses the same approach.

“In the VIP Trading Services, I usually start with a 25% trailing stop (though the stops are tighter in Chairman’s Circle Breakout Alert), but I tighten them as the stocks go higher,” Marc said. “Because these trades are shorter term in nature, I want to ensure we don’t miss out on gains. In the trading services, it’s important to me that you put money in your pocket on a regular basis.”

It makes perfect sense – tighter stops for faster gains.

Then, I asked Emerging Trends Strategist Matthew Carr to dig a little deeper and evaluate all the research surrounding trailing stops. Here’s what he had to say…

There’s always the argument of which trailing stop percentage is best. And I believe for different strategies there are different approaches.

Now, I tend to be more influenced by data – research papers, books, facts…

So, for me, my trading trailing stop strategy was influenced by a 2009 paper on stop losses. This was an 11-year study that went from January 1998 to April 2009.

Not only did it test to see if using trailing stops outperformed “buy and hold” as well as bonds…

But it also tested incremental stop losses from 5% to 55%.

That’s a very wide range. And the findings were consistent…

On a trailing stop basis, the two best performers were a 15% trailing stop and a 20% trailing stop. The third best was 25%.

From my perspective, 20% is in that Goldilocks zone. In that 11-year study, the 20% stop outperformed the 25% stop more than it underperformed the 15% stop.

So that’s why I use a 20% stop in my trading services.

But here’s the one real takeaway from that 2009 study – only one trailing stop level underperformed buy and hold.

And no, it wasn’t 50% or 55%.

It was 5%… That was also the only trailing stop level to produce a negative return over the 11-year period as well.

Stops can be too tight. And instead of helping your performance – because you believe you’re reducing your overall exposure to risk – you’re actually hurting it.

Again, it makes perfect sense.

Truth be told though, there’s no better expert on trailing stops than the Club’s Pillar One Advisor and founder of TradeStops Dr. Richard Smith.

Richard has a Ph.D. in mathematical systems. He’s also a true believer in the power of the Club’s recommended trailing stop exit strategy.

Twelve years ago, Richard set out to create a user-friendly application to easily set and monitor stops for his own portfolio. It was so effective that he began offering it as a service to others. He evolved his application to provide “smart stops” that take into account the historic volatility of each position.

Today, subscribers use TradeStops to manage more than $13 billion in total portfolio values. Members tell us that it has transformed their investing results.

To learn how TradeStops can help you apply the best stop prices to your individual stocks and put them to work in your own portfolio, click here now.

Good investing,

Rachel