Hello Friends! Thanks so much for stopping by and visiting my blog, Stock Picks Bob's Advice! As always, please remember that I am an amateur investor, so please remember to consult with your professional investment advisers prior to making any investment decisions based on information on this website.
Just yesterday, I was reading an excellent column by Roger Nusbaum about stop orders. He questioned the wisdom of using blanket 8% stop orders that limit losses to 8% on all of your purchases. This happens to be my strategy in my portfolio.
Perhaps wisely, he argued that different stocks experience different volatility patterns. One could say that due to different 'betas', the stocks with larger volatility deserve a larger range to travel, or perhaps one should tolerate a larger loss on these high beta stocks.
"A common strategy for placing stop orders is simply to put one 8% below your purchase price. This has never made sense to me for several reasons. I advocate for tailoring your stop order to your stock, for reasons I'll make clear as I review why using this rule of thumb is more like hitting your thumb with a hammer."
I cannot argue with his thinking. Perhaps it would be better to have a 'beta-adjusted' risk tolerance. But then again, a better question is whether the application of these 8% loss limits is a successful strategy.
William O'Neil, the publisher of the Investor's Business Daily has been a big force for the utilization of 8% loss limits.
O'Neil, in an interview on Motley Fool commented:
"TMF Otter: You've stated publicly that an investor who followed your system would have avoided the egregious losses suffered by holders of Enron or Global Crossing. How would an investor be protected in your mind without also taking the chance of selling out on good companies way too soon?
O'Neil: My rule is simple -- any stock that I buy that declines 7% or 8% below my actual purchase price, I will always without exception, sell to cut short my loss.
TMF Otter: No exceptions?
O'Neil: None. This way I guarantee myself that my capital will never be exposed to a 25%, 50%, or 75%, loss which is always difficult to recover from. So, your first loss is always your smallest loss. The only insurance policy you can take out to protect against a large devastating loss is to cut them all without exception while they're still small."
I have chosen this approach and have found that it has been successful in providing me with the discipline and the rules that are the framework to my trading activity. I avoid making any exceptions; even though I write often about my ability to choose to override any of my rules if I feel it is required.
I also have written about selling stocks even if I have held them for a very short duration. And that is exactly the case with Cubic Corporation (CUB) which I sold this morning, bringing me back down to 18 positions, after it passed that 8% loss limit for no particular reason that I could find.
Earlier today I sold my 280 shares of CUB at $28.6888. These same shares were purchased two days ago (!) at $32.32. Thus, in the very short period of 48 hours, I had managed to incur a loss of $(3.6312) or (11.24)%. In these particular situations, I do not have time to calculate whether the beta of the stock deserves a larger leeway before selling. My decision was terribly wrong for reasons I have yet to decipher.
But that doesn't matter.
No matter what Roger has to say (and I greatly respect Roger for his accomplishments as a fellow blogger as well), I have found that the less exceptions we make to our own rules the more likely the rules will serve us well in the long run.
Those shares were sold without hesitation when I saw the price they were trading at. With a sale at a loss, I do not have permission to replace that stock with another. I applied the proceeds to my margin balance and shall be waiting for one of the other 18 to hit a sale at a gain and I shall try again with another investment.
Thanks again for stopping by and visiting! If you have any comments or questions, please feel free to leave them on the blog or email me at email@example.com.