Art of War Chapter 4 Summary explains the importance of defending existing positions until you can advance them and how you must recognize opportunities, not try to create them.
Translation for investors:
- Never lose money
- Patience is a virtue
Trailing Stop Losses
I have a quick question for you, you don’t have to answer, it’s rhetoric. How many people do you know that have had some sort of asset (land, stocks, house, etc) and seen the value of that asset drop significantly only to hope and pray that it goes back up. Time and time again I witness this with family and friends like it’s a broken record. As investors and owners I know it is easy to get attached to your assets as you have spent a considerable amount of time and money acquiring them but the cold hard truth is not all assets are going to be profitable. Additionally when you “wait for things to turn around” you are causing more harm than good, the further into the hole you get the harder it is to climb out. Take a look at this chart that shows how your asset would have to perform in order to get back to break even after a significant loss.
Technical Definition - A stop loss order set at a percentage level below the market price for a long stock position. The trailing stop price is adjusted as the price fluctuates.
Practical Definition - A predetermined percentage below your entry price that you are willing to lose. This could be 10%, 15% or 25% whatever you determine this will be your “pack up your bags and move on” price point. In other words, if the price falls below this price point it will set off an automatic trigger to sell. However, we all hope that the price of the stock moves upwards and when/if it does your trailing stop moves upwards as well. This mechanism allows you to do three things:
- It allows you to let profits run without selling your position too soon.
- Allows you to cut your losses early to prevent catastrophic loss to your portfolio.
- Literally takes all the emotion out of investing, which prevents you from making a drastic mistake.
A portfolio that utilizes both the tactics of proper asset allocation and trailing stops will have solid defense against stock market volatility. This will GUARANTEE that you never suffer significant loss to your portfolio. And yes I just guaranteed you that you can prevent significant loss to you portfolio. Here is how!
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle”
- Sun Tzu
Do you currently practice asset allocation in your portfolio? How about trailing stops? Do you think the stocks you choose is more important than proper asset allocation?