In the investing world, [the] seven deadly sins apply. These "behaviors," just like in life, lead to poor investing outcomes. Therefore, to be a better investor, we must recognize these "moral transgressions" and learn how to overcome them.
Earlier this week a trailing-stop triggered on one of my investments, netting me 20%. At it’s peak, I could have netted 30%, but that’s the fundamental problem with investing; you never know the peak or the bottom until after the fact and that’s why greed and pride can be so powerful in the market and it is for that very reason that I use trailing stops to protect myself from myself.
See, when an investment is going good, the urge is to hold out for even more return potential. And when things are going sour, the urge is to hold the losing investment, hoping it will rebound and you won’t lose your money. That’s why you need to make two decisions before you buy an investment and then use those decisions to automate the buy/sell action:
For my longer investments, in which I don’t expect to need the cash in the next couple of years or more, I’ll leave the trailing stops to follow the investment ever higher, as I did with CNQ, locking in more profit as the stock price increases. As long as I don’t need the cash and the price continues to climb, there’s no reason not to continue to lock in profit potential*. But at the (pre-defined) first sign of trouble, the trailing stop sells automatically.
In the graph below, the green “B” marker between Feb and May’13 is the point where I bought shares of CNQ. The red “S” marker at the end is where I sold all shares and exited the trade completely after the price fell 15% from it’s high of $46.51 in July. Could the 15% loss be the end of a correction? Sure. Could it be the beginning of a precipitious fall to $2? Sure. That’s why you predefine your goals and automate the actions.
I’ve been extremely cautious recently, with the market continuing to hit new records while analysts who are smarter than me question the validity of the rise. Here’s how I’ve been cautious:
Standard caveat: Don’t be a douche. I’m not giving you financial advice so don’t sue me if your potfolio tanks.
Depending on where the investment is — if it's a new investment that hasn't appreciated enough, the stop-loss is just that; stopping my losses from being too great. If the investment has appreciated into the profit zone, the stop-loss protects my profit.
My portfolio is very focused and not at all diversified, requiring more diligence and awareness on my part.
I have a hard-ceiling at 50% at which point I'll sell the original investment and leave the profit in to continue to perform.