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When somebody on this board mentions the word stop, the effect is hardly less spectacular than when Moses commanded the waters of the sea to divide. As in that case, the most comfortable place to be is in the middle. Sometimes stops are useful, sometimes they are the opposite. Some stock trading strategies wouldn't work without stops, other trading strategies stop working with stops. Broadly speaking, the technical, chart pattern people need and love stops, and the value people couldn't care less. Do you see Warren Buffet placing a stop? Let alone the HUGE One?
There is just one justification for stops: that they work. If they don't, forget them. So, do stops work with $$$MrMarket$$$'s method? My brother pointed out that in his 50 odd closed trades, only 5 would have been stopped out at -20%. Wouldn't that be more than compensated by avoiding huge losses (read BEL, PRX, NUTR, and perhaps also CBK)? Time for some calculations.
I started with the info on http://hometown.aol.com/ebarsamian/ as per november 15, 2004. I valued all closed positions at +15% and the open positions at their then current return. The average return per position is 6%.
Watch out, the normal or arithmetical average is 8.6%, but we need the geometrical average. The normal average is calculated as (15%+15%+...)/(number of returns); the geometrical average as the (number of returns)th root of (1.15*1.15*...).
It is moderately obvious that a tight stop, like the -8% often mentioned, is no good for $$$MrMarket$$$'s method. Quite a few stocks would be stopped out, hurting the returns awfully. So what about a wide stop like the -20% proposed by my brother? It would mean that from the 62 winners since January 2002, 11 would have been stopped out. That is awful, but the open positions compensate. Only 2, SPF and MCRI, would be open; the rest would add a -20% loss, for an average loss of -16.4%, compared with the current -26%. But the compensation is not enough: the total average return drops to a paltry 2.9% per position. I also tried a still wider stop, of -33%, but while better, it still doesn't cut it. The average return per position is 3.8%, which just doesn't compare with 6% for no stops at all.
Conclusion? Stops have no place in $$$MrMarket$$$'s method, not even to avoid the occasional stock going bust. And if you are a wimp and can't face the red in your positions? Put your money in a savings account, or, better still, get some spectacles with red tinted glasses, so the red numbers become invisible.
Regards,
Karel
There is just one justification for stops: that they work. If they don't, forget them. So, do stops work with $$$MrMarket$$$'s method? My brother pointed out that in his 50 odd closed trades, only 5 would have been stopped out at -20%. Wouldn't that be more than compensated by avoiding huge losses (read BEL, PRX, NUTR, and perhaps also CBK)? Time for some calculations.
I started with the info on http://hometown.aol.com/ebarsamian/ as per november 15, 2004. I valued all closed positions at +15% and the open positions at their then current return. The average return per position is 6%.
Watch out, the normal or arithmetical average is 8.6%, but we need the geometrical average. The normal average is calculated as (15%+15%+...)/(number of returns); the geometrical average as the (number of returns)th root of (1.15*1.15*...).
It is moderately obvious that a tight stop, like the -8% often mentioned, is no good for $$$MrMarket$$$'s method. Quite a few stocks would be stopped out, hurting the returns awfully. So what about a wide stop like the -20% proposed by my brother? It would mean that from the 62 winners since January 2002, 11 would have been stopped out. That is awful, but the open positions compensate. Only 2, SPF and MCRI, would be open; the rest would add a -20% loss, for an average loss of -16.4%, compared with the current -26%. But the compensation is not enough: the total average return drops to a paltry 2.9% per position. I also tried a still wider stop, of -33%, but while better, it still doesn't cut it. The average return per position is 3.8%, which just doesn't compare with 6% for no stops at all.
Conclusion? Stops have no place in $$$MrMarket$$$'s method, not even to avoid the occasional stock going bust. And if you are a wimp and can't face the red in your positions? Put your money in a savings account, or, better still, get some spectacles with red tinted glasses, so the red numbers become invisible.
Regards,
Karel
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