Hi
Disclaimer: I'm a total novice in this game - haven't even purchased my first individual stock yet!
I am currently seeking to nail down my first investment strategy, and I reckon I'm about 80% there. The main area that I'm struggling with is when to sell?
By way of background, I have been amazed at the wealth of information there is out there - both online and in books. The first book I read was Dreman's Contrarian Investment Strategies. Think perhaps it was a bit too heavy for a beginner, but the data is pretty hard to argue with on how value investing performs. I've followed this up with much reading from the web - mostly from Stockopedia and Investopedia, which have been incredibly helpful in my understanding. I think Dreman's approach is a bit too blunt instrument, so I will add a focus on quality to all my investments - from my wider reading this seems to be a (no-brainer!) pre-requisite for any decent investment strategy (as opposed to trading strategy). I'll base my picks on high Stock Ranks and high Quality scores, throw in diversification of sectors and caps, and rebalance every 6 months - I feel like this could be a good approach to take.
Where I find most debate though is around when to sell? There seem to be contradictions around cutting your losers quickly but giving them the opportunity to grow as well?
My current thinking is to put in a trailing stop loss of approx 10-15%, taking into consideration the normal volatily of the individual stock and tweaking accordingly. I know that for many this is heresy but I'm comfortable with missing out occasionally if I limit my exposure. What I am also wondering is do people use moving averages in relation to stop losses i.e. once share price moves below a moving average it's time to sell? Is this advisable? What moving average - 21 day/50 day/200 day?
Hope this stimulates some debate. Please pitch in if my plan sounds disastrous.
Thanks in advance
Nujinho
Very interesting subject. Certainly deciding when to sell is more tricky than when (and what) to buy.
I do not use stop losses, but even if I did, 10 to 15 per cent seems way too low. I have had very good returns from stocks where I would have been stopped out under these rules, but those stocks went on to perform very strongly. In at least two cases I more than doubled my initial investment.
The other reason I would avoid your strategy, is that a 10 per cent market correction could result in the forced sale of half your portfolio. This is precisely the time when you should be doing the exact opposite and buying more stocks when they just got cheaper.
I tend to focus on the performance of my overall portfolio in relation to the overall market, rather than the performance of individual stocks. Many investors seem to be too hung up on individual losses. People feel the pain of a 30% loss more than a 30% gain, This is obviously irrational as the material loss versus material gain is the same. Really, the only function of stop losses is to deal with this irrational fear.
Lets look at some numbers. Since May 2013, I have invested in 65 different high StockRank stocks. Three of these investments lost (or have lost) more than 30 per cent in value (Plus500, Amec, Sweet Group), but 23 gained more than 30 per cent. None lost more than 50 per cent of their value. In contrast three went up by more than 50 per cent, while another four were up over 100 per cent. Overall, 45 investments were winners and 20 were losers. But more importantly, my winners increased my portfolio by £96,399 while my losses decreased it by only £11,809.
If that doesn't convince you, here is an academic paper which basically says that stop-loss strategies do not work:http://www.cass.city.ac.uk/__data/assets/pdf_file/0020/124355/Stop-Losses-v8.pdf
My general approach is to use StockRanks themselves as a sell signal. I use the combined StockRank score with the Guru screen count as both my buy and sell triggers. My initial sell trigger was a combined score of 90, but I have since dropped this down to 80. The main reason is that it seems that momentum is a really important factor in generating outsized returns, so you want to run your winners for as long as you possibly can. I also keep an eye on the QV rank which can be used as an indication of whether the stock is getting toppy. If this drops below 60 then it is probably time to consider selling.
By all means, if stop losses help you sleep at night then by all means do it. If like me, all you care about is overall returns, then I wouldn't bother. Overall, I am achieving a 30 per cent annualised gain since StockRanks were launched in mid-2013. My basic philosophy is to trust that StockRanks will highlight enough high potential stocks, diversify sufficiently, be patient, and focus on portfolio performance, not individual stocks.
Good luck (and as always DYOR)
MB
