This the editorial of our monthly Shareholder Yield Letter published on 2023-10-10. Sign up here to get it in your inbox the first Tuesday of every month.
More information about the newsletter can be found here: The best large cap investment strategy ever
In this issue you can read how to implement the trailing stop loss rule in your portfolio and what you should NEVER do!
But first the portfolio changes.
Portfolio Changes
Buy Four – Sell One
Four new recommendations this month as the MSCI World index is above its 200-day simple moving average.
The first is a Hong Kong-based company engaged in the manufacturing and sale of consumer food products with a shareholder yield of 7.1%, share buybacks of 0.6%, and it pays a dividend of 6.5%.
The second is a Japan-based company engaged in the exploration, development, production and sale of oil and natural gas products with a shareholder yield of 9.1%, share buybacks of 5.8%, and a dividend yield of 3.3%.
The third is a US-based financial services company with a shareholder yield of 9.1%, share buybacks of 5.8%, and a dividend yield of 3.2%.
The fourth and last recommendation is a Hong Kong-based manufacturer and seller of beverages with a shareholder yield of 9.6%, share buybacks of 4.0%, and a dividend yield of 5.6%.
Stop Loss – Sell One
Sell HP Inc. at a loss of 8.6%.
How to implement the trailing stop loss rule
Here is a question from a subscriber that may also interest you:
“Until I thought about it for a while, I was not aware of the difference between your 20% Stop Loss practice and simply setting a 20% Trailing Stop Loss limit within my broker’s system.
Then I realized that the biggest difference is that, while you investigate the last month - in other words, 20 or so, closing prices - the latter follows all intraday up's and down's of a stock, thus being much more volatile (and executed more easily). I think it would be helpful for the community if you could go more into detail on this in a future newsletter.”
Before I answer the question first a bit of background information.
You and your stop losses
We get a lot of questions about the stop-loss system we follow in the newsletter so I thought it is something you would also like to know more about.
First a bit of background information.
I did not like stop losses
Until about 2015 I did not follow a stop-loss strategy.
A bit of testing led me to believe that a stop-loss strategy leads to lower returns, even though it did reduce volatility (large price movements up or down).
But you know we look at research all the time and, at the start of 2015 I found three papers that tested stop-loss strategies with very insightful results.
Result of the research
I won’t bore you with all the details here, you can read the full article here: Truths about stop-losses that nobody wants to believe
The research clearly proved that stop-loss strategies work!
Here are the main points:
- A simple stop-loss strategy provided higher returns while lowering losses substantially
- A trailing stop loss is better than a traditional stop-loss (loss from purchase price)
- The best trailing stop-loss percentage is 15% or 20%
- If you use a pure momentum strategy a stop loss strategy can help you completely avoid market crashes, and even earn a small profit while the market loses 50%
- Stop-loss strategies lowers wild down movements in your portfolio, substantially increasing your risk adjusted returns.
The difficult part - your emotions
Even if you are convinced of the idea of stopping your losses the difficult part to implement it is to not let your emotion keep you from selling when a stop-loss level is reached.
This is important because to get a stop-loss strategy to work for you is you MUST stick to it, not once but over and over and over again.
I am sure you already experienced that your mind tries to trick you into holding onto a losing stock because selling and realising the loss (before it was only on paper) is emotionally painful.
NEVER leave a stop loss order with a broker
To answer the subscriber’s question.
We recommend you never leave a stop loss orders with a broker.
You know anything can happen and daily price movements can be wild. Take a look at this flash crash explanation on Wikipedia to see just how wild – what is a flash crash.
This means if you leave a stop loss order with your broker there is a good chance that it may be executed even though the closing price may not be much different from yesterday.
Only look at the stop loss level once a month
Because of these wild movements, and to keep trading costs low, for the newsletter we only look if the 20% trailing stop loss has been broken once a month – on the day the newsletter is published. I suggest you to the same or something similar.
Remember to include dividends in your stop loss calculation
As mentioned above. Remember 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%.
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.
How to implement your stop-loss strategy
This is how you can implement a stop-loss strategy in your portfolio, it is also the stop loss strategy we use in the newsletter.
- Implement a trailing stop-loss strategy where you calculate the loss from the maximum price the company has reached since you bought it.
- Only look to see if the stop-loss has been triggered monthly. If you look at it daily, you will trade too much, and the costs will lower your returns. This may look like a too long period but since 2015 we have found this works well. A lot of companies that fell below a stop loss during the month ends up above the stop loss level when the newsletter is published which makes the position a hold. If monthly makes you uncomfortable you can also look at the stop loss level weekly. We do not recommend daily as that will cause you to trade too much.
- Sell your investment if at the monthly evaluation date, the trailing stop-loss level of 20% has been exceeded. You can also use 15%, it works just as well but may lead to more trades.
- 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 Euros or US Dollars. This ignores currency movements.
Include dividends in the stop loss level. Add any dividends per share you have received back to the current share price when calculating the trailing stop loss. Remember stock prices fall with the dividend per share number after a stock traded without the right to the dividend.
What stop loss strategy do I follow?
I follow a 20% trailing stop loss system in my portfolio. Most of the time.
Let me explain.
If I own a very volatile stock, I may follow a 15% trailing stop loss that I look at weekly. For the rest of my portfolio, I follow a 20% trailing stop loss I look at monthly.
Remember, as with most rules in investing there is not just one right answer. The right answer is what works for you and lets you sleep comfortably.
You can of course not use any number or rule. That's why we do a lot of back testing and look at research papers to see what has worked in the past over up and down markets.
For example, the research we did on stop losses found that a 15% or a 20% stop loss work best.
For the newsletter we selected 20% to keep your trading costs low while at the same time keeping your losses low.
It will not always work
The studies all showed that a stop-loss strategy works over long periods of time. This of course does not mean that a buy and hold strategy will not sometimes outperform your stop-loss strategy.
But over the long term it will reduce your portfolio’s volatility (large losses) and increase your compound investment returns.
This is VERY important because it will help you stick to your investment strategy when the market makes wild moves!
It will also give you the courage to buy new investments, even in difficult market conditions, because you know exactly when and how you will get out should things go wrong.
System that sells your losers to invest in your best ideas
The main advantage of following a trailing stop loss strategy is it gives you a disciplined system to:
- Let your winners run,
- Sell losing investments fast and
- Invest the proceeds in your current best ideas.
And this is the best way to make sure you have outstanding long-term returns.
PS The Shareholder Yield newsletter is published on the second Tuesday of the month so look out for your next issue on Tuesday 14 November 2023.
P.P.S. Here is information that can help you get the most from your subscription
How we find ideas for the Shareholder Yield investment newsletter.
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