What would you do?

KGriff

noggin1980 wrote: »

I didn't misunderstand you, you misunderstood me and that was completely my fault.

Sorry mate I shouldn't have been cheeky and just explained, the person you have been agreeing with on this thread had a long debate on another thread about stop losses. He was really very rude about someone who didn't sell there mining fund after it had dropped very significantly.

He believes in using stop losses to cut your losses when you are down over say 20%

I completely agree with everything you wrote in that post and have no criticism of it.

Noggin1980 ... Thanks for that. I must have missed the earlier stop-loss debate. Clearly I have a different view to others about stop-loss orders, but I know investors who share the same view that it is a 'tool' to cut their losses... I've never seen it that way. I think It's really trying to maximise your profit in difficult times.

As it was in the thread where teamaria (a new invester) was seeking advice to invest her £40-50,000 I thought I should just seek to clarify and highlight the possible different viewpoints on stop-loss, particularly as many in this thread have suggested that tiamaria should invest quite heavily in a stocks and shares ISA.

TakeCareOfThePennies_2

noggin1980 wrote: »

His and your views are almost the complete opposite, he believes you should invest more when the share price has fallen or at least hold your nerve and believes using a stop loss to accept a certain level of loss is poor investing and perhaps even the path to ruin.

Whereas you are really quite insulting about people who hold onto a fund that has plummeted and your method of investing is to always and without further thought sell a stock once it's reached your predetermined stop loss something like -20%.

You are most welcome to hold and/or invest more .... up to an extent.

That's why I have my 'soft' and 'mid' review points. The investment has already had two chances by the time it reaches 'hard'.

There has to come a point though, when you cut your losses because you realise you've now got your hands on a dog.

If the story behind an investment has changed so much that the value has considerably dropped, and that drop is not down to a broader market crash or temporary market correction, then there really are very few reasons indeed why you should consider clinging on for dear life wishing it will go back up.

I've said it before. One of the most important rules of investing is learning when to sell. "Sell with regret" as they say. That applies in both directions, taking profit and cutting losses. You should always be prepared to do both, irrespective of your bullish feelings for the investment.

Investors are optimists at heart. The downfall of many an investor has been to continue clinging onto dogs, hoping and praying they'll go back up, desperately seeking out confirmatory bias through view points that agree with their desire, only to to be left in the end with a pile of dog poo left by the dog.

TakeCareOfThePennies_2

KGriff wrote: »

a new investor such as tiamaria, who started this thread to seek advice and was being advised to ’heavily' invest a lot of their £40-50,000 virtually straight away in stocks and shares.

My position was that I thought tiamaria should begin with a slightly more balanced or cautious approach to stocks and shares that's why my earlier advice was to opt for the 123 account, a cash ISA and the remainder (£9,760) for use in early share trading.

This indeed..... :T

paramaniac1

KGriff wrote: »

Paramaniac1,

Just to clarify, a stop-loss order is 'most likely' only ever put in place when your stock or fund is high and the stop-loss would (or should) still provide you with a profit above the book cost. I'm not sure your post clarifies that position.

Otherwise you ought to be throwing more money at the stock or fund, whilst its share price is low. Why sell it at a loss? I don't see that as a good strategy. I'm sure you will go onto clarify your post.

Investors should hold their nerve or even perhaps use 'other' alternative stock or investment purchases, to offset a loss.

The stop-loss is a safety net, set above the book cost, taking fees and cgt into consideration.

However I have seen many use it to accept a level of loss on their investment, which to me is the path to poor investing and eventual ruin, or at the very least, a poor return on their shares portfolio.

I hope you don't mind me trying to clarify your comments, as there are lots of relatively inexperienced investors here on the forum who may read this thread.

Unless anyone here disagrees with my own views on a stop-loss order?

A stop loss order is just an instruction to exit a position when the price reaches a certain point. If i were to buy 1 share of a company for £10 I would have risked £10 (it may go down to 0 and i have lost my £10) If i put a stop loss at the £9 position, and the share started to go down i would automatically sell at £9 losing £1. In this way my risk only becomes £1 and not £10 (which it was without the stop loss). If the share rises the stop loss moves up automatically ( share rises to £11 stop loss rises to £10, share rises to £12 stop loss rises to £11 and so on) This is known as a trailing stop loss. If the share rises to £20 and then plummets it will trigger the stop loss (which is now at £19) and i will exit the trade at £19 having made a £9 gain. In this way I would know that my risk on the trade was only ever £1 at any time whatever happens to the direction of the trade.

paramaniac1

brasso wrote: »

So have you followed your own advice, or not? I'd presume you'd have been raking it in over the past few years -- or is it a foolproof system you've only recently stumbled across?

I have followed my own advice and managed to make 31% per year on my investments since 2008 but I did not start with a large amount of capital. However my focus now is only on the returns. Compounding over time will take care of the capital. I have been developing and testing (for over 3 years) an automatic system that trades the US markets using spreadbetting. It works by finding the fundamental and technical indicators that cause stocks to move. What makes stocks moves seems to be different to what we are TOLD makes stocks move. To find this out means collecting large amounts of data and testing to see if there is a relationship between the indicators and the final stock returns. I actually have stated the final test on January 10th and the system has returned 13.24% against 3.33% for the US market index up to this point so it seems to be working well. Is it foolproof? No, though I still adhere to the saying that 'you can't beat the stockmarket.... but you can milk it'

brasso

Have you used stop-losses much? You've described the theory but in practice there are plenty of drawbacks. If the share is volatile you can easily sell in error at a low point, missing out on later gains. Unintended sales happen a lot when trading opens and you get sudden rapid adjustments and readjustments. To counter this you may have to nominate a stop-loss lower than you'd like. Also, remember that every sale needs a buyer. If a share starts to slide it is likely to dip well past your nominated sell point before it goes. When I dabbled in stop-losses I found that a couple of times I'd sold right at the very lowest point in a dip, just before the bounce that would have saved me.

These were expensive but useful lessons in my brief trading phase. Using automated triggers sound great but can work against your best interests.

paramaniac1

brasso wrote: »

Have you used stop-losses much? You've described the theory but in practice there are plenty of drawbacks. If the share is volatile you can easily sell in error at a low point, missing out on later gains. Unintended sales happen a lot when trading opens and you get sudden rapid adjustments and readjustments. To counter this you may have to nominate a stop-loss lower than you'd like. Also, remember that every sale needs a buyer. If a share starts to slide it is likely to dip well past your nominated sell point before it goes. When I dabbled in stop-losses I found that a couple of times I'd sold right at the very lowest point in a dip, just before the bounce that would have saved me.

These were expensive but useful lessons in my brief trading phase. Using automated triggers sound great but can work against your best interests.

Imagine you bet on 10 horses in a 10 horse race. 9 won't win but you will pick the winning horse and that one winner might be bigger than the 9 losers combined. If so, you have made a profit. If not you have made a loss. Over time, if your system has a positive expectancy you should end up making a profit even though,say, over 10 races you only picked the winner 10 times out of 100 runners. The advantage of stop losses are that you can limit the losses on the 90 losers. If you place a trade and it gets stopped out, do not dwell on it, move on, accept your loss and concentrate on the winners. Yes many stocks get stopped and then go on to do very well but that is impossible to foresee. All that is important is that at the end of the year the small amounts of winners you picked outweigh the large amount of losers. That is your annual return.

paramaniac1

TakeCareOfThePennies wrote: »

You are most welcome to hold and/or invest more .... up to an extent.

That's why I have my 'soft' and 'mid' review points. The investment has already had two chances by the time it reaches 'hard'.

There has to come a point though, when you cut your losses because you realise you've now got your hands on a dog.

If the story behind an investment has changed so much that the value has considerably dropped, and that drop is not down to a broader market crash or temporary market correction, then there really are very few reasons indeed why you should consider clinging on for dear life wishing it will go back up.

I've said it before. One of the most important rules of investing is learning when to sell. "Sell with regret" as they say. That applies in both directions, taking profit and cutting losses. You should always be prepared to do both, irrespective of your bullish feelings for the investment.

Investors are optimists at heart. The downfall of many an investor has been to continue clinging onto dogs, hoping and praying they'll go back up, desperately seeking out confirmatory bias through view points that agree with their desire, only to to be left in the end with a pile of dog poo left by the dog.

Fundamentals make a stock rise in the long term. Sentiment and emotion cause the stock to fluctuate in the short term. There is not a company out there that makes a consistent profit and the share price falls continuously. If you sell on short-term fluctuations you will lose eventually. If it's a good company with solid fundamentals, stay with it and see the drops as opportunities to buy more, not to sell. That’s what Warren Buffett does.

brasso

paramaniac1 wrote: »

Imagine you bet on 10 horses in a 10 horse race. 9 won't win but you will pick the winning horse and that one winner might be bigger than the 9 losers combined. If so, you have made a profit. If not you have made a loss. Over time, if your system has a positive expectancy you should end up making a profit even though,say, over 10 races you only picked the winner 10 times out of 100 runners. The advantage of stop losses are that you can limit the losses on the 90 losers. If you place a trade and it gets stopped out, do not dwell on it, move on, accept your loss and concentrate on the winners. Yes many stocks get stopped and then go on to do very well but that is impossible to foresee. All that is important is that at the end of the year the small amounts of winners you picked outweigh the large amount of losers. That is your annual return.

As with your revolutionary discovery about how to beat the US stock market, I'm extremely sceptical about this. It's something I can imagine sounding convincing to a naive audience at one of those 'seminars' that tell you how you can get reliable above-average returns simply by applying a system based on logic.

Trouble is, the markets don't operate solely on logic and technical indicators. Things happen outside the trading floor like the war in Ukraine, like a suicidal pilot crashing a plane, like the BP disaster in the Gulf of Mexico, like the ASOS fire, like the Tesco accounting scandal, like Lehman Bros popping like a bubble, and so on.

Regarding your horse race analogy, others here may have more time to rip this idea apart but let me just mention a couple of obvious problems.

Firstly, the parallel is wholly unrealistic because the stock market can't be thought of as groups of stocks in a zero-sum game in which there is one winner and (say) 9 losers. All may win over a period; all may lose over that period. Regarding automated selling, as I said earlier, in order to avoid hair-trigger sell-offs you have to opt for a sell price that is quite a bit lower than you might be comfortable with (and even then you probably won't get that price, especially if there is a big sell-off -- your tiny stake is irrelevant compared with the muscle power of the big sellers). So even using your model, you may end up with a bunch of failing stocks that have cost you a lot, which leaves the winner(s) having to be superstars to compensate.

Going back to the horse race I have to pull you up on this:

paramaniac1 wrote: »

...you will pick the winning horse and that one winner might be bigger than the 9 losers combined. If so, you have made a profit. If not you have made a loss. Over time, if your system has a positive expectancy you should end up making a profit....

Lethal cod-science. "Might be bigger than the 9 losers combined" -- yes, and it might not be. You would need a steady run of high-priced winners to compensate for all the wasted bets. May I ask a simple question: if this is how horse races worked, do you not think there would be hundreds of millions of people doing it?

Coming back to reality, and the markets, what about trading costs? In your model, you are not just buying and selling 10 items but you are paying 20 lots of trading fees which is a massive hit when margins are fine. Again, think how well your winners have to perform to compensate for all those losses and all those fees. And when do you cash in? If your 'winning stock' has put on such a surge as to pay for your day's trading, presumably because of an upturn in business or sudden optimism in its future, do you really want to sell it now? And equally, if a stock is dragged down by a temporary state of affairs that will pass, do you really want the stop-loss to kick in thus cementing in the losses and missing the bounce?

paramaniac1 wrote: »

All that is important is that at the end of the year the small amounts of winners you picked outweigh the large amount of losers.

Profound. Here's another golden tip to add to your stash: Winning a fortune on the lottery is easy. All you have to do is buy a winning ticket.

bowlhead99

paramaniac1 wrote: »

A stop loss order is just an instruction to exit a position when the price reaches a certain point.

Yes, we know this.

If i were to buy 1 share of a company for £10 I would have risked £10 (it may go down to 0 and i have lost my £10) If i put a stop loss at the £9 position, and the share started to go down i would automatically sell at £9 losing £1. In this way my risk only becomes £1 and not £10 (which it was without the stop loss).

Entirely correct.

However, remembering your earlier recommendation that your trading environment be a spreadbet firm, and that leverage be used - such that a £40,000 investment represents £400,000 of real world capital, funded with £40k of your own money and £360k of debt finance:

Your deposit is £40,000 but when the share price is at £10, you are representing £400,000 of assets.

When the share price falls 10% to £9, you are now representing £360,000 of assets. The stop is hit and your position exited. Hopefully you paid the extra fees for a 'guaranteed stop', rather than risking the market re-opening at £8.50 after an overnight news release or mid-session trading suspension and your spreadbet broker exiting your position at the best available price of £8.49 instead of £9.00. But lets say you get out at £9.

The £9 representing your £360k of assets falls rather short of your start position of £10 which represented £400k. You have lost £40k. That £40k loss can be seen in your margin account moving from £40,000.00 yesterday to £0.00 today. Total wipeout.

So, if you have leveraged up your position to 10x your margin, you cannot afford a share price to move 10%; that 10% loss is 100% of your investment on that trade. To manage your liquidity risk you would need a very diversified set of positions and/or you would need to set the stops at 1% instead of 10% so that only a tenth of your capital could be lost.

If you are managing risk through diversification of position and accepting the 100% loss potential on each of them, you will need a lot of positions. Hopefully your system for identifying great trades finds you a very large number of great positions. And even when it does, you would still be in trouble on that day where the whole market drops by 13% with every single position being down 10%+, stopped out with 100% loss.

paramaniac1 wrote: »

Imagine you bet on 10 horses in a 10 horse race. 9 won't win but you will pick the winning horse and that one winner might be bigger than the 9 losers combined. If so, you have made a profit.

The logic is correct. However, the chances of your one winner returning more than you lost on the others is rather low because that's how bookies make their money ; whether the bookies overall margin is slightly negative or slightly positive, a market has assessed the odds of what might happen, in order to set the price in the first place.

For example, you could be £10 on each of 39 horses that started the Grand National. Costs you £390. One of them wins. He gets you 25 to one, which is a £250 return plus your £10 stake.

The odds are skewed so that the ones most likely to win have much lower odds (e.g. AP McCoy's "Shut the front door" was a top 5 finisher, but only paid 6-1 returning you £60 if it came in). This is akin to Apple having a good chance of surviving on the stockmarket over the next 5 years but already being priced over $700bn, so if it 'comes in' and turns into $1000bn, it will not make so much money as all those failed tech startups which you spent $500bn on.

There is some logic to the fact that the market, overall, rises and so if you invest in 'everything' you will make money. Unfortunately as you compartmentalise the market into individual buckets of stocks and buy all of them with tight stop losses, you will get a lot of individual funny or idosyncratic results which rattle through your stop losses in no time. The only way to play the game is to know which ones are going up and only bet on them (impossible) or to bet on all of them and accept huge variability and peaks and troughs on the way to the end goal, which means stop losses can't be used effectively.

An 8% compound return does not mean you get something going 100, 108, 116.64, 125.97, 136.05, 146.93, 158.68 in a straight line for seven years. You get 100, 111, 117, 104, 130, 85, 158.68.

If you got wiped out when the market drops over 10% from 117 to 104 or 35% from 130 to 85, you never reach the end game. During those periods, your daily or weekly trades go Stoploss Stoploss Stoploss LittleWin Stoploss BigWin Stoploss Stoploss Stoploss Stoploss Stoploss Outofmoney.

Frankly, the fact that your 'system' has generated a return in excess of a cap-weighted index since January 10 in a broadly rising market, is not something that demonstrates investment prowess or proves a system works. More interesting are the results from summer 1999 to 2003 or the 12 to 18 months leading up to March 2009. If you got a good result in both those periods it is only because you have used the historic data from those periods to build the system with the benefit of hindsight. Which still doesn't mean that in the next, different type of crash, your system will fare well. So, I don't think anyone here is recommending that others follow your strategy.

As a side note - it is probably not a very appropriate system for the OP "tiamaria", just like it is not a very appropriate system for most casual investors. But as they dropped in their throwaway question a week ago and have not commented or replied to any of the 100 responses since, it is a fair bet that they already invested their £40k on lottery tickets, won, and emigrated with the proceeds.