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Friday, 13 September 2013

The 3 Ms Part 2 - Money (episode 1 of 2)

Money is for money management.

Most investing books don't talk a lot about protecting your profits and minimizing your losses. 

I think retail investors can learn a lot from traders in this regard. Not to become traders; but improve on their money management skills. 

For example, if you have bought Singapore REITs during the end of 2012, you could be sitting on 40% unrealised gain by May 2013.

Now in September 2013? The unrealised gains have either vapourised or turned into a loss...

I know.

During the height of the dot com craze in 2000, I was up 50%, and I watch it turned into a 50% loss... I was like the deer frozen by the headlights of the on-coming car. The aftermath ain't pretty! (My first crash what! Now I know hope is not a strategy. LOL!)


Method is more about entering a position. Let's assume you don't do short selling. Method is mostly about buying.

Money in a way is about selling.  

Selling to minimise losses; selling to protect profits.

In this episode 1, I'll discuss about selling to minimise losses. In episode 2, it will be selling to protect profits. (Like that also can? Boo! What!? I happy or you happy? I can speak pia kia too)


Sometimes I read in forums that someone "cut-loss" at 50% loss... That's not cut-loss. That's capitulation.

Most retail investors are very cavalier on their unrealised losses than their trading counterparts. 

Why?

Hard core traders normally trade leveraged products like CFDs, futures, spot forex, etc. The transaction costs are much lesser than equities trading. Traders know very well that to trade, they need chips. Once their account is busted, no chips, no trades.

Retail investors? Especially if you are still working, there's less sense of urgency. If your $50,000 position gets a 50% hair-cut and is now worth $25,000, it's not really a problem if you have $25,000 yearly reinforcements from your savings devoted to "investing".

Average down and once reversion-to-mean happens, you can even brag about your 2 bagger win on that reinforcement segment!

Of course that's provided the stock you picked is not a lemon.

Even if so, next year another $25,000 is coming! Hope springs eternal!


Why use stop-loss?

It's insurance against big losses. Like disability and hospital insurances. The premiums are gone forever if you don't make a claim. You want to "save" on the premiums by not buying these insurances? Right... That's until you got unlucky and that's when you realise the yearly "loss" in premiums are small potatoes compared to your hospital bills and loss in income...

A good example is the recent China Minzhong incident. If you had a 20% stop-loss with your broker, you would have been stopped-out with a 20% loss.

I know later events unfolded to make this 20% loss a bit "stupid". 

You have to ask yourself this: 25 other S-chips have gone to zero. This CMZ is 1 out of 26 to have recovered. Were you smarter or luckier than investors in the other 25 fallen S-chips? Was this 20% loss premium worth the mental gymnastics you had to endure? Your stomach, you decide.

If you are interested to buy "insurance" to prevent big losses in your positions, feel free to explore and start your own journey in this area. (By now you know my style - I sing song only; I don't have lofty goals to educate others. That I leave to the bleeding hearts.)

The most commonly asked question is where to put my stop-loss? I can only say the usual range for equities is from 5% to 20% - depending on your Method and Mind. (Be mindful trading books usually meant leveraged products when they say don't risk more than 1-2% of your capital)

Don't worry. Experiment! It's like tuning a radio station. Move the knob left, move right, then ah! Just right!

Why 50% loss cannot be a stop-loss point? Eh... To recover from a 50% loss, you need to double your money. How often have you done so? Remember, to recover from a 20% loss, you need to have a 25% win - and that's more achievable and realistic.

The next commonly asked question will be: "Alamak! My trading platform does not provide stop-loss orders!"

Now you know how brokerages treat retail equities investors as compared to retail traders for leveraged products. You pay more in commissions but you get less? What gives!?

Well, there's such a thing called broker-assisted trades. Yes, your dealer or remisier can do the stop-loss setting point for you, and yes it will cost more than DIY internet trades. Unless of course you are a big time retail investor where you can always negotiate for discount. (Is this your best price?)

Another way is to upgrade your trading platform to something like Phillips Protrader - you get access to more advanced order types. The first few months is free as a trial, but after the trial period you have to pay on a monthly basis.

As in life, you get what you pay for. 


Don't use stop-loss also can!

Of course can! Well read retail investors may counter that Peter Lynch don't use stop-loss.

Peter Lynch averages 29% annually for the 13 years he was managing his Fidelity Megallen Fund. (How I wish I can find a star mutual fund manager like him for my CPF investment funds!)

If you are good at picking winners (superior Method), the only Money part you care about is protecting your profits. And rightly so! (See? I never say are you Peter Lynch? My EQ high or what? I know, I know, I kenna sai)


Portfolio management

If you practice this technique of not allowing a single stock position taking more than 5% of your total portfolio, you don't need to use stop-loss too. 

You already have your own risk management in place the moment you enter into a new stock position.

50% loss of a stock position? That's only 2.5% scratch at portfolio level. Even a 100% loss is at max a 5% paper cut at portfolio level. 

But please hor! Having 20 REITs in your portfolio is not portfolio management OK!?


Big War Chest (people E cup you B cup; don't compare!)

I have alluded to it in the beginning. Let's say you can contribute $25,000 annually to investing - that forms part of your war chest.

Compare this to someone else who is able to add $100,000 from passive income, and another $100,000 from active income into his war chest annually.

Who do you think can better put out the fires in their portfolio?

Flat war chest? See first signs of fire you stomp on it immediately like a rhinoceros in Africa (I got watch the Gods Must Be Crazy - remember this movie from the 80s?); you don't go "Hmm... I think something is burning..."


I better stop here. There are many more money management techniques out there besides using stop-loss. Have fun searching!

Stay tuned for episode 2 - protecting profits. Coming soon. (Eh! You don't so hum sup can?)






22 comments:

  1. ya very smart, sent the entire army!

    ReplyDelete
    Replies
    1. what happen to your portfolio if the whole market crash and you are not protected!??

      don't tell me you spread across the entire universe of stocks.

      Delete
    2. looks like you gonna get "hantam" from both traders and investors too haha..

      Delete
    3. coconut,

      Don't look at me!

      Those that 100 stocks in their portfolio found out themselves in 2008/09 how it really works for them.

      Like in a class, there are top students and then there are those that bring up the rear.

      Some may even say portfolio management is not having 100% in equities... Different asset class anyone?

      What to say to equities retail "investors" if they don't like gold (no yield), don't like property (not liquid and leveraged), don't like bonds (with interest rate spiking!), and don't like cash (rotting in bank).

      How?

      Delete
    4. don't worry, market has its own way of taking money from them.

      Delete
  2. ok la, i'll throw an atomic bomb and thats it.

    don't look at historic price to decide your present portfolio, what last year price got to do with this year price where condition in the market had all but change?

    if you compare your purchase price all you see is nothing but profit or lost, thats all. and your action will only based on it and not current market conditions.

    whether trading or investing, trade with the market, not your P/L.

    ReplyDelete
    Replies
    1. coconut,

      I talked about similar stuff in my post last month:

      http://singaporemanofleisure.blogspot.sg/2013/08/value-trap-and-margin-of-safety.html

      Retail value "investors" have a 3rd dimension call "intrinsic value".

      To me, value investing are for the minority how are smarter and not afraid to go against the crowd.

      Both qualities I lack. So I do Trend Following.

      Now trend followers will really hantam me!

      LOL!

      Delete
  3. I cannot find the right term to describe my investing style. My investment portfolios are all having unrealized losses status at the moment. Also l have 13 realized losses to-date due to bad investments. To me, unrealized losses are not all hopeless cases but when it is truly a bad investment then l will not hesitate to bite the bullet.

    ReplyDelete
  4. Also, l reckon stop-loss is necessary only when you are into trading and not meant for investing. Unless it is a bad investment investors should not practice stop loss, as investment capital will be reduced almost immediately. And as you had mentioned, "winning" back this lost capital can be an uphill task. For traders, if there is no stop-loss strategy then it will be suicidal.

    ReplyDelete
    Replies
    1. Money Honey,

      We believe what we want to believe.

      That's why I made the effort to bring in other examples of where we don't need to use stop-loss. Between the lines, these alternatives require higher level skill sets ;)

      Stop-loss is for the average Joe.

      Being wrong is one thing. Knowing we are wrong and remaining so is another thing altogether.

      Traders and investors have the same objective - make money.

      The objective surely cannot be to break-even from our unrealised losses?

      Delete
    2. Money Honey,

      Leave aside this topic of stop-loss for now.

      May I humbly suggest you review your "Method" - or price entry?

      I think your portfolio results are trying to tell you something.

      Tracking and measurements are like the speedometer and fuel gauge in our cars. What's the point if we don't look at them and navigate accordingly ;)

      Delete
    3. When we measure our investing or trading result against time; it will tell us straight into our face. Like it or not. Hide it or not. Believe it or not. But we can't run away from the fact over time.



      Delete
  5. Hi Smol

    I hv many friends just because they bought the stock for 2 dollars at the peak, he is unwilling to sell and rather sit on unrealised loss. Even if the price goes up to 1.98, he is still unwilling to sell because it is still below his buying cost. This is precisely the reason why i dont update my buying costs these days as i dont find it useful. After all what you've bought is bought and done.

    The next step is to determine whether a stock is overvalued. If it is i will sell even if the share price is below my buying costs.

    ReplyDelete
    Replies
    1. B,

      I too have gone through the same journey as your friends.

      I think it's called anchoring bias or some other kind of bias. Learned that from Bully The Bear's LP.

      Trust me, I am not holier than thou ;)

      I'm just an average Joe who just have the ability to laugh at myself.

      Yes, you are on the right path. The market doesn't care what price you've bought.

      There must be reasons why we enter into a position. If the reasons are no longer valid, why are we still in?

      Hope?

      Delete
    2. Some will wish for a hope or a miracle or even an emotion will deter one from selling. So many are trapped into such situation that i find it miraculous when i asked why are they still holding on to a stock. I used to be guilty of those in the past but not anymore now. I hope that will help me better.

      Delete
    3. Less emotion and no heartache method when some losses are expected.

      Stock Picking is like Choosing your own durians?

      Delete
    4. CW,

      Ha ha! You have 2 durians that went to zero, I got one.

      I hope less experienced readers will read our experiences as a form of "cheerleading".

      We can learn and profit from our mistakes! LOL!

      There are 2 kinds of sharing in blogosphere:

      1) What I will do in the next 10 years

      2) What I've done for the past 10 years

      It's good to have a balance of both!

      Youth, your biggest strength is you do not know what cannot be done. Remember it!

      Experience, our biggest danger is comfort zone.

      And now you know why I surround myself with BOTH groups :)

      Delete
  6. i have 2 stocks since their IPO times. One is Koh Brothers who seem to make "a lot of money" all these years.The company even buys back their shares in the open market from time to time. But why retail share holders like me get no return at all?
    Please go and check what are they doing with all the "profits"?

    The other is Rotary Engineering. At least i made some money.
    At times,
    i have not really used "Stop Loss" but i have clenched my teeth and sold in order to savage what is left. If not i can't even see any residue left.

    If i am not wrong sometimes, traders are most afraid "stop loss" can give them headache call, "WhipLash". Not that longer time investors don't encounter them.
    It's just looking at it in different time frame for both of them.
    Ha! Ha!
    There that's my "Stop Loss"

    ReplyDelete
    Replies
    1. temperament,

      Stop-loss (mechanical or discretionary in your case) is just one technique to prevent a small loss from getting worse. No different from cutting the toes off frost-bit mountain climbers to prevent gangrene from spreading.

      The different emotions and strong feelings to this technique can be traced to the Mind part.

      All techniques have their pros and cons. Same for stop-loss. Stop-loss is just a lower level technique that most people can adopt, it's more about want to or not.

      The portfolio method will not work if your other 19 "diversified" holdings also tank... remember 2008? All asset class tanked... Except cash, although US money market funds almost... Cash in banks is not safe in Cyprus recently, and in your broker as in MF Global...

      Peter Lynch's method? Fans of him will know he has a knack of picking 10 baggers.

      It's true. One or two 10 baggers will wipe off all the other losers. Just ask CW ;)

      But alas, I've yet to have a single 10 bagger. So I can't use this higher level Peter Lynch's money management technique :(

      It's all back to the Mind. Shh...

      Delete
  7. Ooh found the answer to my question ler. *like this post* :D

    ReplyDelete

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