This article is a website version of our weekly FREE Best Ideas Newsletter sent on 28.03.2023. Sign up here to get it in your inbox every Tuesday.
Estimated Reading Time: 7 minutes
Learn how to correctly calculate your trailing stop loss, an essential tool for protecting your investments against large losses. This post simplifies the process and offers a crucial tip: include dividends in your calculations. By understanding this technique, you'll make smarter decisions and keep more of your profits. If you're looking to refine your exit strategy and safeguard your investments, this article is a must-read.
As I was planning this week’s stock purchases, I kept thinking, what if I buy now and the markets drop suddenly?
There are so many things that can go wrong but then again, a lot can go right.
The thing is, we just don't know what's going to happen, no one does. The world is a complex system with 7 billion people making decisions every day. How can you, I, or anyone else possibly know what's going to happen?
What Made it Easy to Buy Was...
What made it a lot easier to buy was the stop loss system I follow, it is the exact same system we use in our newsletters, Quant Value and Shareholder Yield.
The newsletters followed a strict stop loss system which sells an investment if it has fallen more than 20% from the all-time high.
Here are the steps:
- A trailing stop-loss where you calculate the loss from the highest price the company has reached since it was recommended.
- Only look to see if the stop-loss percentage has been exceeded once a month, on the newsletter’s publication date. If you look at it daily, you may sell if the share price becomes volatile. You can of course look at your stop losses weekly or every 14 days. This will also ensure that you keep your trading costs as low as possible.
- Sell your investment if at the monthly review date, the trailing stop-loss level of 20% has been exceeded.
- Measure the trailing stop-loss in the currency of the company’s primary listing. This means measure the stop-loss of a Swiss company in Swiss Francs (CHF) even if your portfolio currency is Euro (EUR).
- Adjust the trailing stop-loss for dividend payments as the share price usually falls by the amount of the dividend payment.
- Reinvest the cash from the sale in a current newsletter investment idea. This will make sure that you sell losing investments and invest the proceeds in the current best ideas.
Remember to include dividends in your stop loss calculation
This week when I looked at my portfolio two companies were close to their trailing stop loss levels. But when I looked closely this was not so. So, I want to remind you to include dividends when you look at your stop loss levels. Especially companies with a high dividend yield.
As you know when a company goes ex dividend (trades without the dividend) its stock price usually drops by the amount of the dividend. For example, you own a company trading at $1.00 and it pays a 10% or $0.10 dividend it means the stock price will drop by 10% to $0.90.
This means if the company was already sitting at a 10% trailing stop loss, and it falls another 10% it may hit your 20% trailing stop loss level.
But this is not right because the dividend usually gets paid a month or so after the ex-dividend date. This means that you must include the dividend (still to be received) when calculating the stop loss level.
Here's the formula: (Current stock price - the highest stock price + the dividend per share) / the highest stock price. In other words, you add the dividend still to be paid back to the decline of the stock price from its all-time high.
You can read more about stop losses here:
How Trailing Stop Losses Can Maximize Your Returns
Master Trailing Stop Loss for Smarter Investing
Truths about stop-losses nobody wants to believe
Truths about stop-losses nobody wants to believe - Webinar
Your analyst wishing you profitable investing
Frequently Asked Questions
1. What is a trailing stop loss?
A trailing stop loss is a tool that adjusts your stop loss level as the stock price rises, helping you protect profits while allowing the stock to grow.
2. How do I calculate a trailing stop loss?
Calculate it by setting a percentage below the highest stock price since you bought it. As the price increases, the stop loss adjusts accordingly.
3. Why should I include dividends in my stop loss calculation?
Dividends can cause the stock price to drop temporarily, so including them ensures your stop loss isn’t triggered unnecessarily.
4. What happens if the stock price drops after the ex-dividend date?
The stock price usually drops by the dividend amount. Adjust your trailing stop loss to account for the dividend to avoid being stopped out.
5. How often should I review my trailing stop loss?
Regularly review it, especially after dividends are declared or the stock price change significantly to make sure it has not been triggered.
6. Can a trailing stop loss prevent losses entirely?
No, but it can minimize losses by locking in profits as the stock price rises and turns around.
7. Is a trailing stop loss useful in volatile markets?
Yes, it helps manage risk by adjusting to market conditions while keeping you invested during upward trends.
8. What percentage should I set for my trailing stop loss?
It depends on your risk tolerance. Common percentages that work best are 15% to 20%.
9. What if my stock is close to the trailing stop loss level?
Consider if the stock is still a good investment. If yes, adjust the stop loss; if no, sell.
10. Can a trailing stop loss be used with any stock?
Yes, but it’s particularly useful for stocks with a strong upward trend to make sure you lock in your profits when it turns around.
PS To find great companies that exactly meet your investment strategy right now click here.
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