Using stop losses with Momentum

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8th Oct '16 by plank

31 comments 14982 reads

I can understand why the value investor is not in favour of stop losses but may even use a fall in price to purchase more. However the investor who uses momentum as a guide for entry would use stop losses.

I read an article recently suggesting that a stop loss between 15 and 20% used in an arbitrary fashion increased returns.

It is laborious to try to back test this on stock ranks as it is very difficult to see what past Stock ranks have been

Does any one use momentum in ranks as a guide for entry and use stop losses for exits? If so how successful has that been and how do you set levels?

Thank you

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About the Author

Plank

Premium Member

31 comments

Noodle Hat

10th Oct '16

The point of stop losses are to protect your capital. Probably the most important part of investing.

The argument that the drop is temporary or chops you out is neither here nor there. they help you make money in the long run by not loosing it in the short term. The obsession by alot of PI's that they must be right on every stock is a key factor in underperformance.

Mark minervini, bill O'Neil, Stan weinstein all hammer home point if this.

the key message from minervini book.

Rusty2

10th Oct '16

Yes of course no system will work all the time, it's about finding a system that works best for you. Having tried various stop loss systems I don't generally use them anymore, on certain shares which I consider more risky I may well have one. One problem is the stop loss is not guaranteed, I have read articles which make out the most you will lose is say 15% this is not true if there is a profit warning, the shares can fall before market opens by more than that, writers of some articles fail to mention this. Also on some shares which are liquid you can't sell even at a lower price. The good thing about stop losses is it takes the decision away from you. Also market makers can push the price down to trigger stop losses so buy up shares on the cheap that has happened to me.

WarrantStar

10th Oct '16

I don't use stop losses at all. But I have the good fortune to be able to be able to spend six hours a day watching my portfolio. I'm mostly into small caps and it seems quite likely to me that using stop losses in a market crash would cause many of my shares to be automatically sold when It's not it's not really in my interest. I generally sell on fundamentals. Often this is to crystalize a profit, and sometimes this is to minimise a loss. Either way I prefer to be in control.

Brilliant Leader

10th Oct '16

I have a slightly different approach to stop losses which may be of interest to some. For each holding I set a percentage stop loss based on a mixture of company size, liquidity, trading patterns and the spread. Typically, the range is 10-20% with the odd outlier at 25%. If the share price rises, I then run that percentage figure as a trailing stop loss.

However, when a stop loss is breached,I do not automatically sell (and I never use guaranteed stops but that's a whole other story) but rather, I force myself to make a new decision; buy, hold or sell and to do this I invariably review my research and challenge my previous conviction. Very rarely I average down unless/until momentum returns. Quite rarely I hold with no further action and most often, I either sell out completely or reduce my exposure.

The other point of note is that I begin my review with seeking an explanation for the price decline - is it company specific, sector or market? This is an important aspect for me, especially if it is a general market sell off as opposed to company specific results/news/rumour. Whatever the assessment of my findings, I must make a decision. It is not always the right decision of course but it does help me to remain comfortable with my investments and my risk. Ultimately, the preservation of capital is more important than missed profits.

A few recent examples from:

Reduced SRT in two tranches at 52p and 42p and I am now looking at its rising momentum but will not add until after results or a further contract announcement.

Sold half ZYT at 350p and am again waiting for results before adding on eising momentum

I was stopped out of a couple of bad buy decisions and I haven't looked back on these since except noticing a few moans and groans on Twitter and Stockopedia; LAKE, NWT, NWF, NXR, ALU. Then again, there were a couple of these that I have subsequently revisited, most notably PEG where I doubled my new holding today upon news of a major contract win.

BVXP was a really tough one. My initial decision when the SL was breached was to retain my holding but not average down. Once momentum returned and the Troponin launch remained on track, I doubled my holding which so far is looking like a good call, especially after today's rise.

This approach of using a stop loss to force a new decision does not maximise profits but it does help to manage risk, protect capital and sleep soundly.

Rusty2

11th Oct '16

Your system looks really good.
I also hold Bioventix (LON:BVXP), I did not have a SL on that, I bought around 755p, so when it fell to around 962p I was still in profit, my view of the company has not changed, I could not really see the reason for the fall, so I bought some more. Now they are 1250p. One thing to note is on Bioventix (LON:BVXP) the spread canbe very wide upto 10%, when I bought at 962p it was very small around 2% for some reason, so it pays to watch these type of shares. I also did the same with £TRSL very similar story, topped up at 110p but with a stop loss I could have been thrown after Brexit, when they went down to 89p, now they are 165p. This takes me on to the psychology of share ownership. The company is the same whether you buy the shares at 90p or 150p but the way you view the company maybe different depending on whether you are in profit or making a loss. The thing is to decide whether it's a bad investment and get out or whether it's just a timing issue.

Of course you don't need a stop loss to sell shares, I know Robbie Burns sells many well before the stop loss is reached. The first link about stop losses is comparing to a buy and hold policy.

Brilliant Leader

11th Oct '16

And just to be controversial, I sometimes sell into a rise. Today's update from VCT I thought was mediocre and yet the shares rose over 10% at one point. I decided it was incongruent with the newsflow and therefore, sold out on the basis the rise would not be sustained. I might buy back prior to results on 6th December IF the share price drifts back between now and then.

Deciding when to sell shares is one of the hardest things but my stop-loss= new decision approach above works well for me most of the time. The other reason I sell (top slice) is when a rising share becomes overweight in my portfolio or like today, when I think a rising share has become overpriced - there is a very tricky balance here between running winners and managing risk.

Rusty2

11th Oct '16

Yes better to sell after a rise than a fall. I top sliced Tristel (LON:TSTL) today, this report is 5 years old, it's nothing new, ok it just been published in some journal but it's not news. So I can't really see why the price has gone up, price going back down now.

Ken Lowes

11th Oct '16

Thanks Grinder, see what you did, a simple statement from a respected player and a meaningful discussion starts up and hey presto loads of views. The next question would of course be how soon was it before you got back into the market? But I will wait for your review for that one. Stop losses are very difficult in my view especially these days where high volatility appears to be the norm. At one time 10% was a respectable stop loss but no longer. A stop loss which is not adhered too is not really a stop loss but often simply a period of indecision.

I think it is a given that momentum is an important factor in the short term investment game. If you are a buy and hold investor momentum is nice to have but not as important as quality and size. Assuming that confirmation of a buy was a 1&3 month green signal, along with all other factors being satisfactory, would you not / should you not sell when these indicators turn red. This is difficult to back test but at least it might protect you from the falling knife syndrome or selling too soon. I appreciate that there are bound to be times such as a gap down or profit warning when you have to take the pain. But the lights would probably still be green for a little while which will give you the benefit of a partial recovery until the reds appear signalling the sell--- or not. Conversely if you wanted to buy into a bombed out sector not doing so until the chosen share had turned to two greens might protect you from a further reversal. I put this forward in the hope that someone out there has tried it and it works or doesn't. Perhaps I should finish on the note that if one "day trades" stop losses are imperative when using a spread betting platform, as IMHO discipline is essential if you are going to be one of the 5% who make money. No good for me as discipline has never been my strong point.

Richard Medland

13th Oct '16

Apologies for accidental thumbs down Ken, small tablet, big fingers... This subject really highlights just how disorganised so many of us are re pf management. I now try to make a new decision each time a price moves 10-20%. Easy if fundies have changed but usually its just the normal noise in which case its a hold or add. HOWEVER.... I also consider pf balance between defensives, high yielders, punts etc where my objectives may differ. My best move was to adopt a small opening position, say 1% of pf, and to add on price moves either buying better value or rising momentum as long as I still have confidence. Smaller entries also benefit from being psychologically much easier to ditch. I seem to be heading for a farming approach where I buy more shares, in smaller amounts to find a few winners to which I'll add (up to 5% pf). Oh yes, nearly forgot, I'm not using stops! GLA, Rich

Rusty2

17th Oct '16

Good results from Bioventix (LON:BVXP) today. A wise decision to average down in this case.

GrindertraderUK

17th Oct '16

Glad to see so many on this thread recognise the positives of Stop Losses. It is about protecting capital by minimising losses. There is no point debating whether ONE stock or another on a particular time frame would have worked if a stop loss was in place or not. Everything to do with stock market investing comes down to simple rules of averaging and stop losses are no different to any other rules of averaging.

It is simple mathematics. Diversify your holdings, start small, stick to some simple stock picking rules and 'on average' you will find most of your picks will win. However..for the odd one or two stocks that fail to perform despite qualifying for stock picking rules that 'on average' work, then place a stop loss. Your cutting losers while letting profits run.

If you get 'stopped out' and the share price bounces back up.. So what! You honestly do not care, or shouldn't care. Why? Because 'on average' with your good stock picking skills your portfolio is still performing well.

There are thousands of posts spread amongst many bulletin boards and blogs giving views from people on why Stop Losses do not work but in my opinion most of these posters are sitting on huge losses, and are in love with their stocks. They will always talk about the winners and give examples of market makers taking out stops etc. But they will never talk about the huge losses they have suffered because they don't use stop losses.

PLEASE consider the many good points in this mostly positive thread. Also remember that many professional and successful investors will also claim not to use stops..... Are you as good as them?

I am reaching out to everyone who is struggling to cut losses and that may be influenced by poster(s) on here giving examples on why stop losses don't work. Please see past these examples and consider the portfolio point of view. Consider the 'on average' view in not only stop losses but in all parts of your investing.

GrindertraderUK

17th Oct '16

I was thinking about last year when I took a shorting position on two sectors. One was retailers and the other Energy Stocks. I wrote two Stockopedia articles on them. The retailers strategy worked but I still had one stock that went the wrong way.

The energy stocks I completely called it wrong. I planned for a worst case scenario and that scenario occurred.

In wrote about these in two separate articles.

Shorting the Christmas Retailers - Bets now Closed 13/1/2016

Shorting the Top Cap Energy Stocks - This shorter got burned! OUCH!

My articles above are real life example of where my confidence got the better of me. My discipline of using stops however maximised my gains on the retailers, and minimised my losses on the Energy Stocks. I planned my total acceptable losses before I did the trades.

If you have time give these two articles a read. They should be thought provoking and allow good real life examples in a 'portfolio point of view' on why using stops worked well for me in both situations.

I am not interested in debating one particular stock in this situation. As said, I view my trading on a portfolio point of view i.e 'On average'.

Damian Cannon

17th Oct '16

I very much agree with your thoughts here. No one gets every investment decision right (whether that means the wrong share, the wrong time or something else) and so it's no surprise that some of our shares go the wrong way sometimes. However this becomes a problem if you're temperamentally inclined to hold on through thick and thin when losing shares just keep on losing - which is where a stop-loss can save you from yourself.

As you say it's irrelevant if the share in question then immediately starts going up because the point of a stop-loss isn't to identify 'crappy' shares and get rid of them - it's there to limit the loss that you're exposing yourself to across the whole portfolio. If you like it's an insurance policy which comes with a certain cost.

Rusty2

17th Oct '16

I'm not saying stop losses don't work, they clearly do work for some people. I was just looking at the NAPS 2016, if you had a 10% stop loss it seems 15/20 maybe even 16/20 would have triggered a stop loss, that's 75% would have been sold, this is similar to what was happening to my stop loss experience. Overall the Naps 2016 is showing a small profit. I prefer the crazycoops method and deciding on each share. Of course you don't have to wait until a stop loss is triggered to sell shares, some people may love their losing shares but I bet most love their winning shares more. Even a 20% stop loss would have triggered 9/20 maybe 10 sales.

The 2 biggest winners Indivior (LON:INDV) +62% and IG Design (LON:IGR) +51% would have been sold, the 3rd winner Drax (LON:DRX) +41% fell over 10%.

Blissgull

17th Oct '16

If I could just add a couple fo comments here.

I usually set a stop loss now as soon as I have bought a share. I understand the comments of crazycoops and others about merely reviewing a share when it reaches a stop loss, but I find it hard to be objective about shares I own. I have found that a "shoot first, ask questions later" approach is better. Dump the loser then review it from an impartial perspective as a non-holder. It may add to costs if you really want to keep the share, but you can always place a limit buy order below the level you were stopped out, and therefore possibly get back in with a small profit from effectively shorting the share.

Secondly and more importantly. I think the question should not be "do I want to keep this share" but rather, "Is this share still the very best place for my capital?" In almost all cases it is very unlikely that the share you are stopped out of is the very best share on the market at that moment in time. Just look at it as an opportunity to rebalance your portfolio.

GrindertraderUK

17th Oct '16

Thanks Bliss, again it all comes down to psychology and how everyone manages their discipline.

Once again a certain poster argues against the stop loss. Yes I believe in debate but this is becoming so tiring. It is a shame really as I feel many new investors will learn the expensive mistakes listening to those against stop losses before they become experienced and proficient in the markets.

Many will not have an exit plan and learning how to place stop losses will at least help new investors think about planning every trade or investment; while at the same time providing protection to their capital.

ricky65

18th Oct '16

I wouldn't sleep soundly at night without my stops. I've read time and time again that reluctance to quit losers is one of the main reasons for PIs to under perform.

I've used trailing stop losses ever since being on the receiving end of a few 50%+ drops due to bad trading updates in my early investing days. I like to look at the chart and identify a support level whereby if it fell through I wouldn't feel comfortable continuing to hold - it's usually around 20%, sometimes closer to 15% and sometimes as much as 35%. I have a weekly review and adjust the stops accordingly. For the most part this has saved me from much pain and helped lock in profits. Occasionally I get stopped out and the share turns back upwards, though in my experience I'm stopped out good most of the time. I wish I had some quantitative proof though.

zeibots

11th Feb '18

Being sloppy with your stops is really getting away from the essential strength of Minervini`s strategy. M tries to get into positive territory ASAP by moving his stop close or above his entry position. To do this is to have the patience to arrive at the precise entry position in the first place.
The current market volatility has a distinct possibility of distorting potential entry points.
Walk away until the overall market is on your side/.

Cranium

11th Feb '18

Spot on Zeibots. The success to Miniverni and indeed O'Neil's CANSLIM strategies is to have 1. Tight stop losses 2. Patience to wait for the ideal entry point and 3. Trading in the direction of the overall market. Current conditions mean that both Miniverni and O'Neil would be sitting in cash - neither is trying to catch the absolute bottom or top of the cycles. In these volatile markets you would constantly be triggering stop losses.

zeibots

11th Feb '18

Yes Minervini has put a lot of work in testing his WHOLE strategy, not just bits of it. Many so called gurus and others will tell us what to do. Minervini does not just talk the talk, he has conclusively shown that he can also walk the walk.There was no hiding place when he demonstrated his skills in open play in the US Investment Championship in 1997. He won with 155% return,nearly double the next nearest competitor.

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Using stop losses with Momentum

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About the Author

Plank

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