Forum Archive Index - June 2001

[Phaedrus <Phaedrus@techemail.com>]

                      A Personal Perspective.
 For many years I relied solely on fundamental analysis when making my 
investment decisions. I did not use stops at all. Why should I? Either a stock 
was worth buying, or it was not. If I bought, and the price fell, the 
fundamental reasons that supported my original decision had not changed. In 
fact, they were stronger than ever. Selling would have been an irrational 
response. I often bought more, averaging down. My stock selection skills were 
such that I was right about 60% of the time. By means of occasionally selling 
good stocks at a good profit, and holding on to my mistakes, I gradually 
selected a portfolio of underperforming stocks. My overall performance was, as 
you may guess, mediocre - consistently underperforming the Index. I was making 
good gains, but my cumulative losses were negating them to a significant 
extent. 
 It was obvious that I must begin using some form of stop-loss, to protect 
myself from losing too much when my initial Buy decision proved to be wrong (or 
mis-timed, as I preferred to think). The obvious solution seemed to be to set a 
given percentage loss at which I would sell. 8% or so seemed about right to me. 
When my next losing stock dipped just below an 8% loss, I reviewed the 
situation. This stock, while volatile, had excellent fundamentals. Its value 
must soon be recognised by the market! I would make my stoploss level 10% in 
this case. After all, 8% was a completely arbitrary figure that I had plucked 
from the air. The stock dropped a little further, and the price seemed to 
stabilise with my loss at about 9.8%. This looked like the bottom. A week 
later, a downgraded profit forecast caused the price to fall 3% overnight. I 
was now looking at a 13% loss. I could not afford to confirm a loss of that 
magnitude by selling, and in any case, I knew the stock was worth a lot more 
than that. Thus I had yet another losing "longterm investment" and my self-set 
stoploss levels had failed to save me from myself. I resolved to strictly 
observe my 8% stoploss level from here on. I did so, but noticed something that 
I found particularly annoying. Quite often, my stop-loss would be hit, I would 
sell, and shortly after, the price would rise, and keep on rising. I raised the 
figure to 10%. The same thing happened, though not quite as often. At about 
this time I acquired my first computer and charting programme. I was now able 
to see trends, and levels of Support and Resistance. The penny dropped. I was 
setting my stop-losses at completely arbitrary levels, unrelated to the stock 
in question. I could see many cases where my stoploss was set just above a 
natural historical price support level. No wonder I was being flicked out of 
otherwise profitable trades. I began setting my stoplosses at just under the 
nearest support level. Sometimes this equated to a 2% loss, sometimes to a 20% 
loss. The difference this single change m

ade to my results was amazing. My stops were now hit surprisingly infrequently. 
In addition, I no longer felt free to shift my stops, because they had been set 
at the level they were by the market, not by me. Many other conclusions 
followed quite logically. By buying close to support levels, I would lose less 
money if the market proved me wrong, and make more if I was right. In a way 
that I find very hard to describe, my new, market orientated approach was 
psychologically liberating. I somehow no longer had my ego on the line every 
time I bought. The market (which I now accepted was bigger than me) would 
decide if I was right or wrong.
  It took me quite a while to get rid of my portfolio of dogs, but I am now 
beating the Index consistently. I am not sitting on a lot of large "unrealised" 
losses, and every single stock I hold is above an established Support level. 
It's easily done - any that drop below are sold. Quickly. 
  My "hit rate" remains at about 60%. The market tells me I am wrong four times 
out of ten.
                              Phaedrus.


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