The Trailing Stop Strategy

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The Trailing Stop Strategy: Protecting Your Portfolio and Your Profits from Market Volatility

By Alexander Green, Chairman, Investment U
Thursday, June 22, 2006: Issue # 548

I’m not happy with our new Fed Chairman, Ben Bernanke.

He promised that his chairmanship of the Federal Reserve would bring the financial markets greater transparency about the Fed’s intentions.

So far, however, all that’s transparent is that he doesn’t know how to send a clear signal to the markets.

Ben Bernanke’s Effect on Market Volatility

First, he tells us that the Fed may not raise rates much further, causing stocks to rally in April. Then he tells us that it may, which caused stocks to tumble the next month. Then, last week, he tells CNBC’s “Money Honey” Maria Bartiromo (over dinner, no less) that the stock market may have overreacted to his inflation comments, causing stocks to swing higher again.

I already miss the days when Greenspan would ramble on for 90 minutes about nothing in particular and traders would doze off in front of their monitors.

To be sure, “Helicopter Ben’s” antics have impacted some of the stocks here at The Oxford Club. The downward pressure in the market has triggered multiple trailing stops and knocked us out of some great companies. It’s been a tough couple of weeks

But Oxford Club members aren’t the only ones faced with managing risk these days Investors across the board are affected by the market’s volatility.

Today let’s look at the way we handle downturns here at the Club It’s a system that has helped us steadily take in profits in both good times and bad. And anyone can do it

The “Safety Switch” – Your Unemotional Moneymaker

After 16 years in the investment world, I’ve witnessed a lack of investor discipline that can lead to big losses – mostly due to a poorly executed exit strategy. Over time, we’ve devised a system called the “Safety Switch” that ensures that

Your losses never get out of control, and
You capture profits while they’re still on the table.

And it’s a mainstay of the Club’s investment philosophy. Here’s how it works

Whenever a stock pulls back 25% from its closing high – or from our original entry point – we issue a “Safety Switch Alert” advising members to sell the stock at market.

Using our time tested trailing stops ensures that we never let a small loss become an unacceptable loss. It also keeps us from us from selling our stocks while they’re still in a major uptrend.

And it works.

Protect Your Profits With Trailing Stops

Since the market peak on May 6, we have stopped out of eight stocks. And here’s the thing: all of them were profitable

We took in 277% on the world’s largest commodity player, which mines everything from copper and aluminum to iron ore and diamonds – BHP Billiton (NYSE: BHP)
106% on a leading global utility equipment supplier, ABB Ltd. (NYSE: ABB), and
50.2% in China from its top oil and natural gas explorer, producer and distributor, PetroChina (NYSE: PTR).

Some investors would say that a broad-market sell off is no reason to get out of these stocks. After all, they’re fine companies, and they may have further to run. Indeed, if they do trend up from here, we may regret the fact that we stopped out when we did.

The important point is that we don’t argue with the market. Yes, we buy based primarily on the near-term business prospects for these companies. But we understand, too, that changes in fundamentals are immediately reflected in share prices. So that’s where we base our sell decisions.

If we start making exceptions, our system will break down. And then – like so many investors – we’ll simply be flying by the seat of our pants, hoping our stocks will continue to rise or stop falling.

I know some investors will object, especially if they have faith in a company

But please don’t tell me about size and strength. Enron was the seventh-largest company in the United States.
Don’t tell me about quality, either. At one time, WorldCom had the most impressive array of telecom assets on the planet.
And don’t tell me about longevity. Montgomery Ward was profitable for 100 years before declaring bankruptcy.

Trailing Stops Not Necessarily The End of the Road

If time passes and we recognize that we stopped out of a company due purely to market volatility and not business fundamentals, we will often recommend a stock again.

The important thing, of course, is to have a sell discipline and stick with it. Anyone can buy a stock. Knowing when to sell it is the true art of investing.

We recognize that our timing will never be perfect. (No investment system devised will ever beat the uncanny accuracy of hindsight.) But, in our view, market prices reflect the prospects for a business better than “expert opinions.”

Using trailing stops protects both your profits and your principal. Not only by taking the emotion out of the investment process, but by basing your sell decisions on the realities of the marketplace.

And that can’t help but make you a more successful investor.

All the best,

Alexander Green

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