Selling related question

[Evolveus]

I was curious if folks here on the board use trailing stop losses, and if so, how do you decide how tight to put them.  Selling is clearly very difficult, and I found that the trailing stop loss can be helpful in that regard.  I wish I would have known how to use them when in '06 I sold my AAPL @ $85.00.  I have toyed with different setups and I'll use my most recent experience as an example.  I would be curious to hear from others if I am am thinking about this correctly.

 

Ticker: £¢§

profit: +56%

 

I wanted to lock in my gain because the price had run a good bit in a short amount of time.  I have only owned the stock about 9 months.  The stock has been pretty volatile, with regular moves of 1.5-3%.  My thinking was that I'll set the trailing stop loss at 6% under BID.  First, I'd lock in a 50% profit (barring a major gap down overnight) and secondly under BID as opposed to ASK since the BID price is the lowest of the two. 

 

Since then, the stock is up another 11% and the trailing stop loss has moved up accordingly.  In this case, it seems to have worked nicely, but I was curious of other risks that may be inherent with using such a strategy.  I know I've been stopped out of things that I didn't want to be out of, and I think that may have been a function of having the trailer too close to the stock price. 

 

My most recent investment read was "Hedge Fund Market Wizards" by Jack Schweger and a recurring theme in the book is to cut losers before they become big losses.  The book does have a lot about trading, and that's not in my DNA, but I have had small losses become big losses before bc I sat idly simply thinking, 'it's ok, because I'm a long term investor.'  I am seeking to remain truly long term oriented while locking in profits and mitigating any losses from becoming bigger than they should.  Curious of the board's thoughts on that.

 

[Tim Eriksen]

I never use trailing stop losses.  In fact, I don't really get the logic of why you would want to use them.  If you estimate intrinsic value and only buy with a large margin of safety, why does it matter if it falls 10%.  In fact, you should welcome it, if you have additional capital to invest. 

 

Nowhere in your question did you discuss intrinsic value.  Did it hit your IV estimate?  Sell.  Is it close to IV?  Reduce.  Why have a position with a smaller gap between current price and IV make up a larger portion of your portfolio.  If it is still far from IV then hold.           

[Liberty]

My most recent investment read was "Hedge Fund Market Wizards" by Jack Schweger and a recurring theme in the book is to cut losers before they become big losses.

 

How do you know in advance where the price is going to go?

 

Picking winners and avoiding losers can be done by studying the fundamentals of a business. But once you've bought something, it doesn't become a loser because price moves around IMO. What matters is how price compares to your estimate of intrinsic value and how fast IV is growing (if it is).

 

Edit: I was looking at it from an investor's point of view, but I guess it can make sense for a trader, though I don't know how to be a successful trader, so I don't really know.

[ShahKhezri]

I use it on Shorts and Trades.  On Core positions that I plan on holding for long term, greater than 3+years, I don't use a trail stop.

 

I used it on gold stocks where the IV depends on the output and cost sturcture (dependent on oil).  Earlier this year, it saved me on ARCO, sold at 19 becaue it hit a 15% trail-stop.  I covered UA at 53 because it hit a 15% trail-stop.  I also sold VRX at $51, so it doesn't always work out.

 

I think it's very easy to say, if the stock is down 15%, 25%, x%, great I can buy more, it's another thing to actually do it.  On LT positions, I can do that, because my position is built through 3-4 quarters and it's not as if I'm buying large chunks, it's just that I like to start small, make sure that management is doing what they said they were going to do and follow that with purchases. 

 

On trades, where I'm looking at 6-9 month holding, trail stops help. 

[anders]

I dont understand the logic of using stop loss, before buying the share you commit yourself to sell at a more attractive price.  ??? I sell when the story changed or at a rediculous high price.

 

Trading is a different story, then technical data is the main driving force so using stops might help you. Just be aware of the algos that calculate stop levels in the market.

[Olmsted]

I don't use stops, too paranoid about flash crashes and the like.  I'm not here to defend them.

 

I do want to comment on the somewhat idealized value investor notion that you research something, determine an intrinsic value, buy at a discount - and if it gets cheaper, great!  Buy more.  It's logical, but I do find it oversimplified.  It kind of presumes that you can out-analyze and out-research everyone else.  Perhaps a selloff is irrational, or perhaps a rational investor with a similar value philosophy just knows more than you do and is selling.  I think it's naive to automatically assume the former. 

 

A declining price has presaged bad news many times in my investments.  A perfect example would be my ill-fated foray into GNW.  After I bought it went up 20%, then proceeded to slowly sell off right back to my cost basis - then boom! Australian unit IPO was called off.  It immediately crashed.  Probably not coincidentally, Baupost's next 13F showed that they sold out at prices close to the top.  Someone clearly had figured out the bad news well before I did.  "The market" was telling me that I had missed something.

 

Situations like these are why people use stops, and why the value paradigm of "if it's cheaper, it's on sale" does not always work.  Sometimes you just don't know what you don't know.

 

Anyone have wisdom on this conundrum?  It is easily my biggest perennial challenge and frustration as an investor.

 

My apologies if I set up a strawman.

[ShahKhezri]

Just to be clear, by trail stop is never in the market, it's just a number that's on the spreadsheet after a 15% haircut from the highest close since I've held it.  I sell the day after a close below 15%. 

 

Olmsted, I completely agree with your thoughts.  Easier said than done.  Generally, if you don't have a position that is a control position, it's tough to have that ideology.  EL is able to do it, I'm not.  Just my thoughts though.

[anders]

Olmsted,

Sometimes you just don't know what you don't know.

 

I have been thinking about this as well.. I think it comes down to the "business eye".. Klarman said that he thinks Buffett is a better investor than he since buffett has a better eye for businesses. He has the ability to see these things coming before others, and he stays within that competence circle. Think about it, his biggest mistake was buying BRK when he was young, he would probably not do that mistake today. A collage student asked him how he manage to do a back-on-the envelope valuation in 5 minutes, buffett responded: "well its 50 years of preparation and 5 min of valuation. So I think it comes down to the exponential learning curve and the skills and abilities to get higher up on that curve. Munger has said that people wont believe how much Warren is reading.

 

Best,

[woltac]

I read the same book a while back and initially thought the stop loss concept would help my returns.  I have yet to find a situation where I wanted to use a stop loss.  Of course, I don't sell very often and when I do it is usually to reinvest in something else, so maybe the concept does not fit my investment style.

 

The flash crash issue also scares me. 

 

woltac

[Guest rimm_never_sleeps]

stop losses and value investing make strange bedfellows.

[Evolveus]

I never use trailing stop losses.  In fact, I don't really get the logic of why you would want to use them.  If you estimate intrinsic value and only buy with a large margin of safety, why does it matter if it falls 10%.  In fact, you should welcome it, if you have additional capital to invest. 

 

Nowhere in your question did you discuss intrinsic value.  Did it hit your IV estimate?  Sell.  Is it close to IV?  Reduce.  Why have a position with a smaller gap between current price and IV make up a larger portion of your portfolio.  If it is still far from IV then hold.         

 

 

I purposely left out comments about valuation, as I am really curious about the mechanics and scenarios of when/if value investors would use a trailing stop loss.  That's also why I put a fictitious ticker symbol.  In this case, I was looking at my estimate of fair value around $22-24 and the stock got there a lot quicker than I thought.  In light of that, I wanted to lock in my gain as it approached my estimate of IV while still giving it room to run if that were to happen, as many times the market can overshoot in either direction.

 

'Cutting losses before they become big losses' is something that is hard for me to wrap my head around.  It is impossible to know which way a stock will go in the short term.  I never start with a stop loss order, bc as Eriksen mentioned above, if I can buy something cheaper with a margin of safety, then I would welcome the opportunity.  Immediately putting a stop loss under a new position seems more like locking in a loss than letting the market be a weighing machine.  The book "HF Market Wizards" definitely has a trading slant to it, which is not my bag, although it did have several interesting chapters/interviews with value folks like Kevin Daly and Joel Greenblatt.   

 

Slightly different version of the question: if a stock hits your estimate of IV, does anyone use trailing stops to capture any unforeseen upside (even if irrational) and put a floor on the downside to existing gains?

[writser]

This guy already expained far better than I ever could why you should not use stop-loss orders: http://kiddynamitesworld.com/aftermath-remedies-dont-lose-faith-in-markets-lose-faith-in-market-orders/ . If you use market orders you will shoot yourself in the foot at some time. What you want to do is "sell at the high" and unfortunately these is no order type for that.

 

If you mean you actually don't use a stop-loss order but define a stop-loss yourself because you have a hard time selling you could calculate your intrinsic value / share, add a little extra and put a good-till-cancel limit sell order at that price beforehand. Don't bother trying to time the market.

[Martian]

I do want to comment on the somewhat idealized value investor notion that you research something, determine an intrinsic value, buy at a discount - and if it gets cheaper, great!  Buy more.  It's logical, but I do find it oversimplified.  It kind of presumes that you can out-analyze and out-research everyone else.  Perhaps a selloff is irrational, or perhaps a rational investor with a similar value philosophy just knows more than you do and is selling.  I think it's naive to automatically assume the former. 

 

Whenver you buy something, somebody is on the other side and selling it. You are already making a bet that you out-analyzed and out-researched the other guy. How come you just realize that only when you bought something sells off? You just need to find a reason why it sold off. If you don't have that conviction, you are just playing with price movements..

 

 

A declining price has presaged bad news many times in my investments.  A perfect example would be my ill-fated foray into GNW.  After I bought it went up 20%, then proceeded to slowly sell off right back to my cost basis - then boom! Australian unit IPO was called off.  It immediately crashed.  Probably not coincidentally, Baupost's next 13F showed that they sold out at prices close to the top.  Someone clearly had figured out the bad news well before I did.  "The market" was telling me that I had missed something.

 

Situations like these are why people use stops, and why the value paradigm of "if it's cheaper, it's on sale" does not always work.  Sometimes you just don't know what you don't know.

 

Anyone have wisdom on this conundrum?  It is easily my biggest perennial challenge and frustration as an investor.

 

Baupost could have sold it for a number of reasons. May be they had a better investment lined up. Or if you think they somehow figured out the IPO call off, you need to go back and reconstruct how you could have found it out yourself. There is no easy way.

 

The key is to choose a company which will not be undone by a single event. Lets say if a company has a customer which contributes 70% of its revenue, and when it loses the customer the company will be sold off.

 

 

 

 

[ERICOPOLY]

Klarman said that he thinks Buffett is a better investor than he since buffett has a better eye for businesses. He has the ability to see these things coming before others, and he stays within that competence circle.

 

Perhaps.

 

I think Buffett's approach in terms of purchasing inevitables is that it makes it easier to be certain that you are getting a discount to intrinsic value.

 

Buying something that looks cheap but later isn't (because the business quickly declines)... isn't value investing.  This I believe is what Warren figured out a long time ago and why he went the way of inevitables or in other words businesses with very enduring characteristics.

 

Some value investors I believe think they are estimating intrinsic value but aren't, yet they do okay anyway because they have a selling disclipline.  In other words, they're out after the first large rally.  So they are trading volatility but don't recognize it as such.

 

[PlanMaestro]

Some value investors I believe think they are estimating intrinsic value but aren't, yet they do okay anyway because they have a selling disclipline.  In other words, they're out after the first large rally.  So they are trading volatility but don't recognize it as such.

 

That's a deep thought. I take back my Eric Roshtein comment.

[ERICOPOLY]

Some value investors I believe think they are estimating intrinsic value but aren't, yet they do okay anyway because they have a selling disclipline.  In other words, they're out after the first large rally.  So they are trading volatility but don't recognize it as such.

 

That's a deep thought. I take back my Eric Roshtein comment.

 

Anyways, I remain invested in my deeply discounted inevitable -- BofA.

 

Most of the volatility traders will be fully out of it long before Buffett makes the really big gains.  Then they'll lose some of their winnings in some stock that doesn't have enduring characteristics.  The sun rises and falls, etc...  This is the investment world that Buffett takes out to the woodshed and fleeces for decades on end.

[racemize]

Klarman said that he thinks Buffett is a better investor than he since buffett has a better eye for businesses. He has the ability to see these things coming before others, and he stays within that competence circle.

 

Perhaps.

 

I think Buffett's approach in terms of purchasing inevitables is that it makes it easier to be certain that you are getting a discount to intrinsic value.

 

Buying something that looks cheap but later isn't (because the business quickly declines)... isn't value investing.  This I believe is what Warren figured out a long time ago and why he went the way of inevitables or in other words businesses with very enduring characteristics.

 

Some value investors I believe think they are estimating intrinsic value but aren't, yet they do okay anyway because they have a selling disclipline.  In other words, they're out after the first large rally.  So they are trading volatility but don't recognize it as such.

 

great post.  really great.

[shalab]

I think Buffett's approach in terms of purchasing inevitables is that it makes it easier to be certain that you are getting a discount to intrinsic value.

 

Buying something that looks cheap but later isn't (because the business quickly declines)... isn't value investing.  This I believe is what Warren figured out a long time ago and why he went the way of inevitables or in other words businesses with very enduring characteristics.

 

Some value investors I believe think they are estimating intrinsic value but aren't, yet they do okay anyway because they have a selling disclipline.  In other words, they're out after the first large rally.  So they are trading volatility but don't recognize it as such.

 

Great post!

[Liberty]

That's a deep thought. I take back my Eric Roshtein comment.

 

You take it back? I thought it was a compliment. Guess I misunderstood you :)

[PlanMaestro]

You take it back? I thought it was a compliment. Guess I misunderstood you :)

 

:) Mostly,

 

I completely endorse the process. However, Roshtein died young most probably killed for debts after a cold gambling streak. Also, he will be forever associated with the Black Sox scandal. You have to know when to retire.

 

But Eric's last comment is not a comment from a compulsive gambler.

 

http://en.wikipedia.org/wiki/Arnold_Rothstein

[Liberty]

You take it back? I thought it was a compliment. Guess I misunderstood you :)

 

:) Mostly,

 

I completely endorse the process. However, Roshtein died young most probably killed for debts after a cold gambling streak. Also, he will be forever associated with the Black Sox scandal. You have to know when to retire.

 

But Eric's last comment is not a comment from a compulsive gambler.

 

http://en.wikipedia.org/wiki/Arnold_Rothstein

 

I took it to be a compliment based on that scene you linked to rather than to the whole life of Rothstein; I like how he talks about waiting for the right moment, and when the odds are heavily in your favor, to bet big, and when there's 'no play', to just work on improving your skills, marshall your resources, makes plans, etc.. Very Munger and Buffett-esque, in a way (except in gambling rather than in investing).

[PlanMaestro]

I took it to be a compliment based on that scene you linked to rather than to the whole live of Rothstein; I like how he talks about waiting for the right moment, and when the odds are heavily in your favor, to bet big, and when there's 'no play', to just work on improving your skills, marshall your resources, makes plans, etc.. Very Munger and Buffett-esque, in a way (except in gambling rather than in investing).

 

Absolutely.

 

The "bet it all" part, especially if it includes debt, is the one to handle with care. But I think Eric, or his mother, also said something like: "do not bet what you cannot afford to lose."

[Liberty]

Absolutely.

 

The "bet it all" part, especially if it includes debt, is the one to handle with care. But I think Eric, or his mother, also said something like: "do not bet what you cannot afford to lose."

 

Yeah, I don't think the "bet it all" should be taken literally - and I kinda doubt that even Rothstein did that - but it goes back to Munger/Buffett and how, when you are sure enough something is a really great opportunity and you've really done your homework, don't put 5% on it... Great opportunities don't come by everyday, so get the most of them.

 

At some point I think Buffett had 75% in GEICO...

[PlanMaestro]

Yeah, I don't think the "bet it all" should be taken literally - and I kinda doubt that even Rothstein did that - but it goes back to Munger/Buffett and how, when you are sure enough something is a really great opportunity and you've really done your homework, don't put 5% on it... Great opportunities don't come by everyday, so get the most of them.

 

At some point I think Buffett had 75% in GEICO...

 

That's a great lesson. And it comes back to Eric's point of also not confusing trading volatility with value investing. Concentration demands a higher quality and certainty from the picks. Better be sure they are not fliers.

 

 

[ERICOPOLY]

But I think Eric, or his mother, also said something like: "do not bet what you cannot afford to lose."

 

It mas my paternal grandmother that gave me that advice.  She passed last year at age 94.  My entire life I remember seeing company reports on her reading table.  She had a broker who recommended a list of stocks to her, and then she would read about each one and tell the broker which ones she wanted to buy.  The broker effectively did her initial screening for her, which is not that much unlike my process.  However my process is to not listen to brokers but rather see what excellent value investors are actually invested in. 

 

She finished up with $12million in equities -- there was a family partnership where my father and his siblings had an equal share, but where my grandmother was effectively the managing partner.  The goal was to avoid Australian estate taxes, but then in the end there were no estate taxes and the whole thing wound up being an unnecessary, expensive endeavor in the end (lots of accounting fees).

 

My paternal grandfather came to Sydney from Stafford (England) in 1949 and purchased land in Palm Beach (near Jonah's), a house in Lindfield, and a large chunk of land in a greenbelt in Pymble (part of which is either now Avondale Golf Club, or right next to it.  I forget which).  The land in the greenbelt he never thought would be developed in his lifetime.  But Sydney rapidly grew and the land was approved for development.  He then sold that land for a spectacular gain -- that gain was then compounded by my grandmother in equities.

 

Last October that house in Lindfield sold for $2,050,000.  It was purchased for less than $5,000.

 

Buying land in Sydney after WWII was the crime of the century -- that's a 10% annualized compounding rate for the house in Lindfield, there are no property taxes, and the family lived in the investment so there is imputed rent not included in that 10% figure.