Trailing Stop Losses
Research for Online Investors

by John Dalt

4/29/09

I am out of the office today to attend a golf tournament. Your editor is a hacker, but today the Big 12 final round is within driving distance. I have a personal reason, our oldest daughter dates one of the players that is currently on the leader board. Golf seems to bring out the best in people. Like many business endeavors, it can also bring out the worst in some people. I will file and addendum later how this plays out.

Today Ken Lewis faces shareholders of Bank of America, it might not be pretty.  Vikram Pandit and his board survived Citi’s shareholders two weeks ago.  There seems to be no limit to the amount of value you can destroy and continue to collect pay and bonuses.  If Ken Lewis’s sworn testimony is true about Treasury and the Fed gagging him about problems at Merrill Lynch, he may be held harmless.  This is tough, should he have quit?  That would have been the principled thing to do, but B of A is his baby, I do not think he would leave unless drug out by the ankles.

Today the first quarter GDP numbers are released before market open and the FOMC finishes their two-day meeting and will have a release shortly after lunch.  Volatility could be the rule of the day with these inputs.

End of day Addendum:
The GDP numbers were worse than the market expected.  The market liked it because inventories are being depleted, as the economy levels off then begins to recover, economic activity will pick up dramatically as there is a smaller supply of goods available.  The FOMC kept interest rates the same, and reported that the downturn of the economy is slowing.  This hints that a recovery may be on the horizon.  I do not want to throw cold water on that warm and fuzzy feeling, but the water is very calm just above the dam!  Ken Lewis was stripped of his Chairman of the Board title today at the shareholder meeting, over 2000 shareholders attended.  In a way, I feel sorry for the guy.  He built a world class bank to have it destroyed by the government in the Merrill Lynch purchase.  Here is the latest Reuters News Release.

Zach Pederson (one of our subscribers) did his teammates, parents and your editor proud today at the Big 12 Golf Tournament.  There are fantastic golfers in our nations colleges, what a joy to watch them.  The tournament was at Prairie Dunes C.C. 6701 yards from the pro tees.  Zach shot 14 over after four rounds in three days.  You can check out the scores here.

Can you think of a better gig that playing golf on scholarship?

This Saturday we are going to try something that may be of help to you. I will be available for one hour on Skype starting at 10 a.m. central time to answer your questions. If you would like to participate, please send your question ahead of time to john@galtstock.com then call between 10 and 11 on Saturday morning at john.galtstock.com We will give priority to questions sent in ahead of time.

Following is an article on “Trailing Stop Losses.”   I encourage you to check the out other special reports under “Investor Resources” on our web site.  Rules for investing are the first step to a disciplined approach that will protect your nest egg and keep you in the game for long-term profits.

Trailing Stop Losses

When managing our long-term investment account we always look for safe investments. No matter how much research you do and great stock market tips you hear in a whisper from a friend at the Christmas Party, sometimes things go bad.  I constantly evaluate each stock in our portfolio.  If you are like many investors, why do you have a stock in your account that is down 70%? Let us resolve in 2009 to limit losses.

We may have up to 20 stocks in our long-term portfolio. Each one of these investments is 5% of our total account. We use a trailing stop on each position of 20%. What does this mean? Let us say we buy Microsoft (MSFT) at $20, the trailing stop is $16 (20 X .80). If MSFT closes at $22, we move the trailing stop up to $17.60 (22 X .80). These valuations are based on the closing price. Never enter the trailing stop in the computer. Wild daily price swings can take out a trailing stop and then close higher and you will have sold out cheap. In addition, if you enter the stop in the computer, the floor traders will dip the market and take out the stops.   Long term as your valuations increase, the trailing stop will leave enough room for the stock to fluctuate as it increases in value. In a general market selloff, or bad news on your company only, your long-term profits are protected by selling at 20% off the highs. By limiting each position to 5% of total assets with a 20% trailing stop, you will never lose over 1% of your total investment account on any closed position!

Doesn't that sound a lot better than sitting on losses of 70%, and trying to decide what to do? It is important to conserve our capital and live to fight another day. I cannot imagine the pain, anger, and frustration of the people that lost everything to Bernie Mad off. We have no one to blame but ourselves, if we do not sell when the selling is good. Sitting on a loser and then waiting for years for it to come back can be like slow death. With a trailing stop discipline, you protect much of the profit you have in your account and reload when the market allows you to make another safe investment. In the above example, MSFT closed at 37.06 on 11/01/07. The trailing stop on MSFT should have been $29.65 (37.06 X .8). I would have set an alert in my trading platform for a close at this level. The stock closed at 29.07 on Feb. 5, 2008, and we sell the stock the next day at open. This price would have protected much of the gain on this stock if you had bought it at almost any time in the previous five years. I would also point out MSFT closed today at $19.30. You could have rode it down to a 48% loss, rather than booking your gain and looked for another great stock for the future.

You may ask, "Must I watch the screen all day to sell since I am not supposed to enter the stop loss in my computer"? The answer is No. We only need to check the closing price daily. This is to adjust the stop loss price up if we have set a new high, and to check if the price has fallen below our trailing stop. Remember, the trailing stop is based on the closing price. If the stock closed lower than the trailing stop, enter an order to sell the next day.

If I have to enter the sell order and leave before the market opens, I like to use limit orders set at the previous days closing price.  Market orders entered on the opening bell can be volatile. A limit order set at the closing price will almost always fill.  If the market gaps up you will get the higher price on the bell, your limit order set a minimum sell price.  Except for a gap down situation, the market will always cross the closing price from the day before.  Unless you are facing a situation where your stock is broken and being sold off like a broken down nag mule, don't enter a market order.  You can use market orders if entered after the open. A companion rule is never buying a stock we have been stopped out of for a few months. A stock that has been a treasured asset in the past does not automatically qualify for future investment potential. Waiting few months allows us to come back to the company with a fresh outlook.

For further reading check out allocation rules, diversity, and expenses at Four Legs of Wealth.

WARNING:    The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor's opinions. It may contain errors and you should not make investment decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any securities discussed. The editor may have held a position in a security earlier, or in the future.

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