Here on The Right Side, we are repeatedly extolling the virtues of risk management. It is not enough to pick the right companies, it’s also about making sure you bank profits while they exist.
In the piece that follows, Dr Steve Sjuggerud, our colleague from across the pond, shares a personal account which demonstrates the most important risk management tool in a long-term investor’s arsenal – the stop-loss…
Regards,
Theo Casey
For The Right Side
What Would You Do With $100,000 of Family Money?
By Dr. Steve Sjuggerud
In 1993, my father did something incredibly nice for me...
He entrusted me to manage $100,000 of his money.
This was far from pocket change... My dad was a career Navy man, and my mom a schoolteacher – not exactly get-rich-quick professions. And neither of them came from money.
I was just starting out as a stockbroker. I have the full academic education in finance, all the way to a PhD. But looking back, the biggest financial education I ever received was from that $100,000...
The money was an enormous weight. This was my dad's IRA money... What if I screwed it up? I was determined not to lose it.
So in my dad's portfolio, I was conservative. I only bought "deep value" stocks and safe income plays. And I only bought once they'd fallen to the point where it seemed we couldn't possibly lose money. (And then they'd go down!)
I wish I could tell you I doubled or tripled his account in a few years. The reality is, it crept forward. And if I didn't have the "tailwind" of a slight uptrend in the market, it might have crept backward.
Meanwhile, I had a client in New York whose account was the same size as my dad's. Ellen was probably 70 years old. But she was not afraid of the markets...
The importance of the “exit strategy”
"My dear, what's Malaysia Fund doing today?" she'd ask.
"It's around $16," I'd tell her. The stock was up from where she bought it.
"Buy me some more of it," she'd say.
"But Ellen, you've already got a big stake in this one, and you can't lose this money. Are you sure?"
"Buy me some more of it."
"OK."
A few weeks would go by. Then we'd have the same conversation, only the fund was $2 higher...
"Where's Malaysia Fund today?"
"It's around $18." "Buy me some more of it."
"Are you sure? This is really getting to be a big stake here..."
"Buy me some more of it."
Ellen's account was going up in nearly every position. Meanwhile, my dad's account was just treading water. My main goal was not to lose his money. I was scared to take a risk. So I wasn't making him much money.
A couple more months went by. I got the same call from Ellen. With the Malaysia Fund at $23, she bought even more.
At this point, I didn't really protest. I didn't tell her this... but it seemed to me she was better at this than I was. Heck, she'd been at it longer than me.
When a stock my dad owned went up 20%, we sold it. I could hardly wait to lock in a profit. Meanwhile, this little old lady from New York was doing the opposite... When a stock Ellen owned went up 20%, she was buying more. And she was making real money.
I wish this story had a happy ending. But like most individual investors, Ellen didn't have any "exit strategy." She didn't use trailing stops or anything else. Instead, she made the all-too-human error of hanging on too long.
In other words, she only got it half right.
Cut your losers and let your winners ride
Nobody taught us this in business school. But around the time I was working with Ellen, I read the book Market Wizards, by Jack Schwager. The guys in the book made their fortunes in various ways... but there was one common thread: These successful traders simply tried to catch the majority of an uptrend (let their winners ride) and avoid the big downtrends (cutting their losers using things like trailing stops).
I hope that – as a reader of The Right Side – trailing stops have helped you ride the big uptrends and avoid the big downtrends. (And if you haven't been using them, I hope the experience of the last few years is proof of their value...)
If you want to make a lot of money in the markets... and not lose much when your stocks go down... then you need to follow the Market Wizards and Ellen and let your winners ride. More importantly, you need an exit strategy to cut your losers early so you can always keep your account heading in the right direction – up.
Good investing,
For The Right Side Steve
Editor’s note: Dr. Steve Sjuggerud is editor of True Wealth, published by our American sister company, Agora Publishing. If Steve’s right about this bear-market rally, it won’t be confined to the US. As always, UK stocks will take their lead from America. If you want to be in the market and are looking for UK stock ideas, check out these potential money makers.
Note: Steve’s article originally appeared on the Daily Wealth website.
MARKET NOTES
China’s fixed-asset investment grows 30% in four months
BY SHIVVY ARORA
In the last bull market, China was the darling of investors everywhere… Since then, it hasn’t been such a hot investment opportunity. But that could be about to change as the economy shows strong signs of recovery.
Fixed-asset investment (FAI) growth in China is growing fast. Figures for January to April show an impressive 30.5% increase on last year. Investments in property, plants and equipment make up FAI and, more importantly, comprise roughly 45% of China’s GDP.
The government’s 4 trillion yuan fiscal stimulus package and expanding bank credit is working better than many analysts expected. And a recent report from investment bank Société Générale offers an optimistic forecast in the chart below.
The graph shows China’s investment growth in fixed-assets (red line) from Sept 2005 to date. It adds the SocGen forecast for the rest of 2009. You can see the upward spike (circled) in the first quarter of this year.
Strong fixed-asset investment growth is a good sign for Chinese GDP
Source: SG Economic Research/CEIC
Majority of the investment growth is in newly-started projects, focused on boosting China’s economy over the medium term. The four-month period saw 86,420 new projects, up 45% from a year earlier.
Total FAI surged by a remarkable 91% to 3.68 trillion yuan. In line with the priorities of the stimulus package, railways have seen a 95% increase over the past year and non-metal mineral mining is up 60%.
Indeed, these figures are impressive. As China’s fixed-asset investment increases, it could shape up to hit the 8% growth for 2009 as officially forecasted by the Chinese government. It’s early days yet, but continued positive newsflow from China may help it regain its popularity with investors.
Daily Reckoning - Calling Time on the Bear Market Rally
London, England
Thursday, 14 May 2009
Have you checked your stops, dear reader?
Remember back in November, we waited for the Obama Bounce? It was the one of the most reliable phenomena in the world of investing, we said. Then, we began to wonder. Month after month... no bounce.
It took a long time coming... then, finally, in March prices headed up. Since 9 March, world stock markets are up 37%. That’s about average for a post-crash bounce.
Now, it looks as though the bear market rally might have run its course. And yesterday, the Dow was down 184 points. We don’t know if that marks the end of it or not. But count us out. At this point, it is far too dangerous to be heavily invested in stocks.
Why? Because the Bubble Epoch is over. The bubble in the financial sector blew up last year. That marked the end of a half century of building up debt. Most likely, now debt is going to be thrown off, shucked, dumped, paid down, worked out and defaulted on.
Without the financial sector puffing up assets, prices will tend to go down, not up. And without the financial sector adding debt and giving American consumers the wherewithal to dig themselves deeper holes, the whole world economy needs to be restructured. Manufacturers in China can’t depend on the consumers of first and last resort in America anymore.
People in the US are no longer buying what they don’t need with money they don’t have. Because no one will lend them money. And so, global commerce slumps. Ships wait at loading docks; where are the containers? Factories wait for orders and stores wait for customers; but where are the customers? But the customers aren’t going to show up. Because if there is one thing Americans have learned from this crisis is that they must stop spending so much money. They’re facing what the Washington Post calls the “Baby Boomers’ Retirement Bummer.” They have no choice; they have to pay off debt, not add more of it.
We’re hearing that China is recovering. We don’t believe it. Who’s buying?
Read on…
To read the Daily Reckoning in full, click here.
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