Assassins and Hunters
Following the recommendation of a forum member (Quest) I've just finished reading the Art of Execution by Lee Freeman-Shor, which I thought was a fantastic book!
I think its pretty clear no one wants to be a rabbit, but wondered what peoples thoughts we on weather it's best to be an assassin and cut losses fast or a hunter and invest as a share falls in order to lower the average cost of your position. Really interesting concept of how it's hard to pick winners, but you can turn losers into winners with the right approach.
As an newbie it feels like using stop losses (assassin) is the less risky approach. I feels like there are only so many times you can get it wrong and los 25% of your stake before you wipe yourself out.
There were a couple of points in the book which I didn't fully understand so wondered if someone could clarify.
Q1 It suggests using at stop loss between 20-30% would this be set on the initial buy price or is it a trailing stop lose that moves up with an increasing share price?
Q2 It seems to suggest focusing on a few holdings with larger positions which contradicts other advice of holding 20-30 stocks. It suggests that by diversifying you aren't de risking just swapping one type of risk for another
Q3 When it comes to not buying liquid shares what's a sensible way to turn that into a screen, from looking at some of the guru screens it seems to imply sticking to companies with a market cap of 30M+ and lass that 5 basis point spread, have I understand that correctly?
Thoughts and opinions greatly appreciated
TBM
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23 comments
If you are unsure about stops and where to put them Stockopaedia risk ratings are a good place to start. Basically the risk ratings are related to volitility which in turn will influence your stop.
Stops are a very interesting subject. As others have said, you have to find what works for you. Personally, I know everyone gets it wrong sometimes so it’s a question of “how low are you prepared to go before admitting you are wrong?” Prices go up and down based on supply and demand in the market. If you think the fundamentals are great but everyone else disagrees, the price will drop. Maybe eventually you will be proved right, or you could be wrong. (Value investors think they are never wrong, they just haven’t been proved right yet.) Even if you are right, there is an opportunity cost.
I like the Bertrand Russell quote ”I would never die for my beliefs, I might be wrong”. Personally I am never going to let a share drop 20%+ below my purchase price because I might be wrong.
Once I have a winner I will let it breathe a bit and then I sell on technicals, or a change in the story. A little technical analysis goes a long way, basically support and resistance levels, stages and bases and moving averages.
As others have said, a lot of books are written for a the American market and are much more trader based, with tight stops etc. I don’t think the Minervini or O’Neil approach translates to the the UK market, but there are still lessons you can take.
I would start with the Naked trader book, maybe Stan Weinstein’s (or watch a summary on YouTube). Then I would build a diversified portfolio of high stock ranking companies and watch them for a year or two. Maybe put an initial stop of 20% on them and once they move up sell half once they breach the 100dma, and the rest at the 200. Exceptions if the whole market tanks. Just an example of some simple rules. Don’t try and over-complicate in the early days. You’ll find your own preferred way as you go along.
Thanks for the wise advise Matt
My pleasure.
I have been thinking on this some more. If you are very good at analysing the accounts, and very good at avoiding all the psychological biases, then averaging down could work well for you. I am not a good enough accountant for that. I know what Warren Buffett would do, but I am definitely not Warren Buffett. I love an analogy: Ali was the greatest boxer ever and fought with his hands down low, it doesn't mean that a beginner should try that style because that is what the greatest did.
In regards to your other questions, for liquidity I try not to buy more than about a third of the average daily volume traded )That is dependent on portfolio and position size). I use google sheets to track my portfolio and it is easy to pull those figures on there. I only screen for it by staying above minimum market cap sizes.
How many holdings is again personal. I like 10-12 as above that is too many balls to keep my eye on. I'd feel a bit nervous with 5, others might not. I can't focus on 20, others might find it easy. There is some research that suggests the benefits of diversification max out surprisingly early. Maybe 10-15 positions? You would have to double check that.
As my portfolio has grown it has meant that market caps have had to get a bit bigger, and I have also diversified into some index trackers and investment trusts.
Diversification is a tricky subject and as MattH has said, if you are good at something then exploit that (think it was Warren Buffett that said "Diversification is protection against ignorance. It makes little sense if you know what you are doing.") so really it comes down to you.
I still don't feel very comfortable in a highly concentrated portfolio, I don't trust myself enough but I'd be equally uncomfortable with a larger number of stocks (20 or more)...as I don't add stocks just for the sake of diversification and at that number, it doesn't make me nimble enough.
If you look at stocks in the same industries, they tend to move together as a group (much more prevalent in the US but does also occur here in UK too, just some of our industries have a tiny # of companies) - check out house builders or airlines for example - if there is industry news, its likely to impact all the stocks together. They won't always follow the exact same pattern but they do tend to trend together. Probably not a good idea to own several stocks in the same area then, try to spread across sectors/industries.
You could also diversify by size (small / mid / large cap) and factor/style (value, quality, growth, momentum, contrarian etc). Although probably better to find what fits you best and stick to it than trying to apply multiple styles, you will just trip yourself up (but you could outsource by buying a fund/ETF)...in terms of focusing on what works for you, I know of traders that only trade stocks which would score incredibly poorly on Stockranks (sucker stocks, momentum traps and the like) but these are often the stocks which can make very big moves in a short period of time as they are the most hated and shorted - to be clear, these are definitely not your buy and hold stocks (e.g. look at Carvana as it came out of the pivot around $12 circa end of May, and if you bought off its lows of $4...you'd have a 10 bagger now....on the other hand if you owned it in 2021, you are probably still sitting on a ~90% loss).
Bear in mind when markets fall, all stocks will fall (even the very best) so probably worth thinking about whether or not you need diversification across asset classes (I have had a large chunk allocated to money market funds in my SIPPs/ISAs and have generally avoided bonds for years although might consider soon as rates begin to peak or at least when I 'think' they are peaking). Lots advocate the 60/40 portfolio although if you had one since end of 2021 through to now, you have likely been through a large drawdown with stocks and bonds falling together...over a long timeframe its probably still not a bad approach though. So another dimension to diversification is asset diversification (stocks, bonds, real estate, cash/currency, precious metals anyone?)...I personally don't have anything in precious metals, have kept well away from crypto and only very occasionally use currency plays fwiw but invest in all the others (directly in residential property rather than REITs but REITs are possibly a better option nowadays).
Then there is geographic diversification - the US market has outperformed the UK for years, Japan appears to have woken up and then there is emerging & frontier markets. Can also help if your currency acts like an emerging market currency (like the £ has for the past couple of years).
You could also consider time diversification, splitting your funds in to long-term (in my pensions I hold funds and trackers that I just leave and keep accumulating, I basically ignore what the market is doing and keep adding based on £ value every month regardless), medium (typically a couple of months to 1 or 2 years) and short term (more speculative account). I personally keep a portion of SIPP money and my ISA money for medium term investments (basically for investing directly in individual shares) and then I have a spreadbet account which has a tiny allocation for short term trades (like a few days to a few weeks and very occasionally same day).
So, just to confuse things, there you have 6 dimensions of diversification:
Thanks for the very detailed overview and insight into different ways to diversify, whilst I'd considered some of these factors laid out clearly like that was really helpful
Hello Brass Monkey,
Not directly related to your questions, but on the subject of whether dead people make the best investors...
Mark Simpson wrote a fascinating article called Long-term stock market winners and losers which shows in three charts the difference in returns on stocks over three timeframes - a month, a year and 30 years. In the comments, he says:
"...we only hear about the winners, not the people who had a coffee can full of poor investments. The Bessembinder study shows that the longer the time horizon, the fewer stocks make the grade so the chances of having a winning coffee can declines."
In the article, he references his earlier article, Screening for 100 baggers which also covers the coffee-can / dead people stories.
Best of luck in all your endeavors!
Indie
This is not a disagreement with anyone (just to be very clear) as you absolutely have to work out what works for you.
I have dabbled with stop losses and they're just not part of an approach that works for me. I have settled on very long term buy and hold. I will sell and accept that sometimes I'm just too slow but I prefer that to being stopped out or snatching profits. I sell on operational performance rather than share price performance. Although they mostly work hand in hand relatively, sometimes in a general sell off they can be operating better than ever while falling in price, and for me that's buying time not selling.
To compare my approach to Wolf's I have not sold out at all, have had to stomach a big drawdown and am still around 20% down but (big but) had I a) called the top which I know I can't or b) let stops sell my holdings I know I would not have bought aggressively after the drop because I know I can't a) call the bottom or b) override the fear that having gone to cash that things might drop another 20%. I just can't do it.
What I can do is be fairly sanguine about a 20% drawdown (and not sell at the bottom) as long as the businesses themselves are still operating well. I view myself more as a business owner than trader. I have every confidence that my portfolio will recover in time as long as I'm in the right companies. Not everyone can watch thousands fall off their pf and not worry too much so you have to work out what will work for you, and it'll probably take trial and error, and losses.
Spot on, have to do what works for you. There are some fantastic long term investors, way better then I could ever be. I'm crap at at, Id be 90% certain I'd not beat a tracker ETF over the long term.
I agree it is a good book, really you could get the key information in a single chapter tho, but it would be a thin book :)
I can only speak for myself but my results completely changed for the better when I fully embraced stop losses, results before this were very mediocre. 20-30% stops are far too large tho, I work on the basis if I get 50% of ideas right 50% wrong I'll still make money as long as I let winners run, so Iooking to lose no more than 8-10% on average.
You really do have to be fanatical about selling tho, only takes one or two big losses to wreck months of profits. I also never ever average down, but where possible always look to add to winners. Selling losers quickly but leverage up some winners, that's the ideal. If I'm wavering over a sale I sell half, its mentally easy then to sell the rest next day or two. Profit warnings go asap at any price. I've sold hundreds of times for losses, it just becomes a natural thing to do.
Its simple but it's not easy, takes discipline and a leap of faith for the first year or so.
Great insight and advice. What's your approach with the stop loss do you set on your entry point or use a trailing stop loss. Forgive my ignorance but with a tighter stop loss of 8-10% are you not exposed to normal volatility that a share has previously shown (is that called beta) and also when it goes ex dividend does the price not drop by that amount and you might get stopped out of a good share unintentionally (is that called whipsaw?)
Depends on the individual share how big the stop loss is, maybe 15% for something volatile 5% for tight FTSE250.
More important for me is timing the buy properly. Don't want to just randomly buy a company with no trading updates until October as it'll get stopped out during choppy periods. If they get stopped out more than normal I stop trading or half the normal buy amount. It's better if you buy with a short term trigger coming up like trading update or results you know or think will be good, or wait until trading update to make sure everything's OK first. Even better in a rising general market. Ideally looking to buy as momentum is building again from a low base. (I use a chart with stochastic/macd) Momentum comes like waves.
Remember you want someone to buy your shares 15,25,50% higher than you paid for them, so I ask myself why would they? What improvement is coming in 4-6 months to make someone buy from me at a premium to what I paid? In a bull market you can rely more on the greater fool theory but in tricky markets it needs something eye catching.
One which worked recently was Concurrent Technologies (LON:CNC) the trading update on Monday was good, short and longer term trading forecasts pointed to growing earnings. Broker upgraded EPS. It didn't gap up thankfully so gave a very good risk reward buy.
Markets are tricky right now so I try to stick to companies trading well with growing eps forecasts. Trying to eliminate a profit warning as much as possible. I'm banking profits a little quicker than usual this year because so many drift back down over time when momentum runs out.
Stick with it in these tricky markets because it's great practise, if you can do OK now you'll be amazed how easy it becomes in a bull market with a tailwind. Everyone has a different personality, just have to find a style that suits yours.
I'd also recommend reading all trading update RNS every day. Play the game of how will the share price will respond to this news. You'll start to pick up the types of news the market likes and have a good idea what % move is likely. Go back over lots of recent risers and read the previous 12 months RNS to spot when and why it moved. Youll see what the market likes and when institutional buyers moved in. Look at the weekly chart and volume to see if there were clues.
As you can tell I'm a trading geek so could talk about this all day:)
Thanks Wolf, really appreciate you taking the time to provide such a detailed follow up. Last couple of questions if I may and then I'll not keep pestering you.
What's the best way to learn basic charting, I've heard of Macd and support and resistance but really don't understand it it.
When you say short and long term trading forecasts is that in the numbers or determined from charts?
When you say stick to what's trading well - What do I need to look at to determine that (chart or numbers?)
Cheers,
TBM
Id watch a few youtube videos on MACD to start. You dont have to get all technical it just complicates things.
A daily and weekly candle chart with macd and volume.
Momentum is very powerful, just look at the US markets right now. Risk reward now is pretty terrible but momentum drives it higher. MACD picked almost every decent move up+ down there in the last year.
When I say short and long term forecast im talking EPS mainly plus pbt/free cashflow. Get this from reading updates/brokers and Stocko eps forecasts.
Setup an eps upgrade screen here and filter for eps upgrades. Look at Quality screener here. Read all trading updates RNS every day from profitable companies.
Once you have a watchlist of companies then use charts for entry/exit points.
One last thing about stop losses. They protect your capital in normal markets, but even more important they stop you being wiped out in big bear markets and flip your mentality from fear to possible opportunity. Last year I was stopped out of lots of holdings so had to take a short term hit. I went big % cash, but when the market bottomed in October/Nov I could be really aggressive buying. If id been fully invested , my portfolio 30% down, the mindset is completely different. Its negative and tentative because Im mentally scarred from paper losses and have no cash to buy bombed out companies still trading well. Some people can handle being 30% down on paper no problem. I cant so need a mechanism to prevent it
Cheers Wolf you've certainly given me a lot to think about, looking forward to a weekend of YouTube and playing around with the screener a bit more. Really appreciate your guidance
I would agree with Wolf on the above on stops. I'd rather get stopped out a couple of times for small losses and then try again than to hold through larger drawdowns and recovery (which might not come). Try to find what you are comfortable with. I found I ended up exiting positions before stop loss was hit because I had sized too big and could not stomach the drawdown, only to watch the stock turn and rocket past my buy point so position sizing and your psychological make up are a really big factor. You also need to assess not only position risk but overall account risk (if you have 30% of your account on one stock and it gaps down 50% on a profit warning, can you stomach a 15% drawdown on your whole account? A stop loss will not save you in this instance as the stock gaps). You need to answer these things before you put your hard earned money at risk.
Stop placement is hard and really depends on the stocks character (some behave nicely and move up in a uniform fashion, others behave like a bucking horse) but you need to make sure you don't provide liquidity to MMs doing a stop run so it has to be sufficiently far below (but not so much that you end up with a big loss) - you can scale in/out (like sell half if your first stop is triggered and then the rest if your 2nd is triggered). You also have to be prepared if you can handle the ones you get stopped out of that go on to make large moves (I was in SMCI last year and earlier this year, it was a superstock on here; got kicked out twice for ok profits and I didn't get back in a 3rd time (I was out at just over $103 per share on last trade, it now trades at $308; my first entry was around $67, exiting about $84...so I missed a huge move if I would have held on...but this is a volatile stock, I used to try and hold but its very hard to hold a stock with conviction if its moved up a lot and then reverses all of your gains and turns to loss and keeps falling - it happens; I prefer to lock in profits now and am trying to find better ways of keeping more of that profit).
I found stop losses in a crash, as after the Brexit vote to be useless, I was trapped in those shares, I could cancel the stop losses, they did not clear for many hours. So you lose control of what price you can sell at. Stop losses are not guaranteed, I've had some where they did not get sold because there was no market to buy them or you get a much lower price than the stop loss.
Very good book to read. Harder to implement the advice.
My biggest loss came from trying to be a hunter. You’ve got to be really sure of a stock that is falling if you are going to average down.
I now try to be an assassin. It’s hard to accept the loss but it’s better to have a portfolio of shares going in the right direction.
Great questions!
For Q1. One approach might be to restrict your trades to assets that require a stop loss of less than 15% (as calculated by the formula 3.3xdaily ATR). If you use a trailing stop loss (good idea) have large steps (say 10% of purchase price, rather than small steps which could lead to getting stopped out early). My personal view is that 30% is far too much to lose on a trade. I'd rather wait until the price is right and risk losing the trade. If you're very keen to take a high risk trade, my suggestion is to buy a small stake and watch what happens before buying more.
This is just a personal point of view and not advice. Not very adventurous I'm afraid. I'd be interested to read what others have to say.
Concentrate to accumulate wealth, diversify to protect wealth. I think even WB said something along the lines of: ‘it’s ok to ‘put all your eggs in one basket and watch it very closely’.
Re stop losses, best to have a mental stop closer to price at key level on a chart, and a ‘save me’ stop order further away; placement takes some time to get the hang of. More liquid shares allow for tighter stops. Remember that risk is dynamic, so SL’s should be constantly reassessed vs price; any gains are YOUR money now, not the market’s. Paper losses are still losses, whether you’ve ‘realised’ them or not.
For a screener, you may want to add a filter such as ‘member of FTSE 350’ or similar.
Good luck with your trading / investing.
I also thought it was a good book, however in total contradiction I also read and article where a large broker had examined it's best performing clients and found the inactive accounts belonging to customers who had died and the portfolios left forgotten were the outstanding group.
For every article book or youtube vid on investing there's another one saying the opposite. I started out reading book after book thinking if I just studied and learnt more I'd unlock the key to success, my thinking was one more book and I'll get it.
All books are different, some tend to be based on single strategies, some offer insights into multiple ones. As PI’s / retail traders, we need to focus on mastering one of them…. Everyone is different, so best to take what’s learned and find what suits your own risk profile, this is the hard bit as it involves a lot of self analysis!
Also markets are different, most of these books are based on the US markets, what works there may not work over here. Tight stop losses, will take you out, nearly all the time, on UK small caps. Spreads are much wider here, even buying/selling small amounts can be difficult. Dealing costs in the US are much lower also, some platforms are free, although the UK has improved slightly recently. Many of the authors would not invest in the UK.
Yes I was going to mention dead people were reported to be the best investors.