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?)