06-01-2020: The Stop Loss Tightrope

While this next statement may not resonate with you, it is nevertheless, totally true:

"You never make a dime (other than maybe dividend yield) by buying the right stock at the right time."

Think about that statement... You have, quite likely, spent hours and hours... indeed, most of your investment life... hunting for just the right stock to buy at the right time. You listen to the talking heads on CNBC tell you, ad nauseam, what the next great stock is and why you should be buying it right now. You have been brainwashed (well... may YOU haven't been brainwashed, but I am pretty sure your investment buddies have) into thinking that buying the right stock at the right time is how you make real money in the stock market. But, dear reader, I am here to tell you, unequivocally, that is simply not true. What follows next, is the real truth:

"You ONLY make money by selling the right stock at the right time."

Unrealized gains are just that... unrealized... until you sell and turn unrealized gains (or losses, for that matter) into cold hard cash or lack thereof. Selling... NOT Buying... is the key to making money in the stock market.

Don't get me wrong... It IS better to buy a potential winner than a potential loser, but in either case, you don't make ANY money on the trade until you sell it at a profit. If the average investor spent as much time thinking and planning about selling as they do about researching and buying, most investors would have far better track-records.

Now, here is the conundrum... When to sell? The answer is easy, you should sell at the high. Everyone knows that.

I know... I just made you mad... sorry.

Actually, the first step or decision you need to make is that you even believe in selling. Some investors don't believe in selling. These are the buy-and-hold investors. They are going to hold onto that Berkshire-Hathaway stock even when it drops 50% because, they know that it will eventually come back. They don't want to hear about the time-value of money and how much time (and profit generating capability) that they will lose just getting back to even. I don't have time in this missive to address the fallacies of buy-and-hold as an investment strategy. Let me just summarize by saying it is one of the worst investment strategies ever created and it has the highest risk of life-changing losses of any other strategy other than just guessing.

This past Friday, our Aggressive Growth (AG) portfolio (formerly known as ULTRA-MAX) grew by nearly 2%... should we have sold at the close on Friday? Maybe. Today, that same strategy jumped higher by almost 2% again. Surely we should have sold at the close today... right? Not as far as I am concerned. One of our AG holdings (ZM) ripped higher today by well over 14% and is now up almost 30% in just 3 days since we added it to the portfolio. I mean, how greedy can you get? Shouldn't we sell it right now?? Nope... not yet, but that's not the whole answer.

I use mathematically derived stop loss settings on every holding. If the total market is moving along at a measured pace, my stops might be fairly wide, giving each holding plenty of room to fluctuate within its 'normal' trading range. At other times, when the total market looks particularly delicate (as it is right now), I tighten stops significantly.

This week, for example, in my Tactical Growth portfolio, I have tightened stops about as tight as possible and am updating those stops daily. In the 12 holdings we have in play at the moment, I tell my clients every week, exactly how much they stand to gain or lose if 100% of the stops are triggered and sold at the current stop loss settings. As of the close of market today and after updating stops, a complete stop out of all positions at their stop loss prices would result in a net profit (excluding management fee) of almost +4%. For that to happen, the market would have to drop rather precipitously and it is already under water by well over -5%. Think about that... locking in a profit while the market tanks. This is the objective and goal of our investing efforts.

In reference to the ZM trade... it has now moved into an "overbought" condition, according to my algorithms and that means its stop loss setting has been moved to well above its basis and thus (virtually) locking in a profit if the stop is triggered.

In all of the above, there is no guessing... there is no jumping into and out of the market based on emotional whims. It is all math, rules and discipline.

The market may tank tomorrow. If it does, we will suffer a minor loss in some holdings, but will capture real profits in most.

Yes... there is a tightrope that we walk between letting a holding have room to move and taking a profit. No stock goes straight up. All stocks move up in a zigzag pattern. The key is to know the difference between a zigzag down in normal volatility and a zigzag down that is the beginning of a major sell-off. We have math to help us determine the most likely scenario.

This does not mean every trade is made to perfection, where we get in at the bottom and get out at the top. Our goal is to get in when the stock has established a good upward trend and get out when that trend appears to have ended. Those decisions are math-based. No guessing. No emotion.

Sometimes a trade defies logic and the best math in the universe cannot keep it from being a losing trade. Monday-morning quarterbacks (of which we include ourselves) can readily see what should have happened. Sometimes, our exegesis of a failed trade helps us improve the process. Sometimes, it is simply a part of life in the stock market.

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