Smart Trailing Stops
Nobel-winning behavioral finance teaches us that when emotion is taken out of the equation, profits and capital are better protected.
What is a Trailing Stop?
The idea behind a Trailing Stop is simple; a value, either a percentage (or price) or fixed dollar amount, is set after a position has been entered into, typically as a stop loss order or contingent order. And when that value is reached through a stock’s price drop, the decision to sell is automatically made. Trailing stops only move up. So that if the price is rising, your stop will “trail” behind it to the value specified and you will always keep those increasing profits. Most online brokers offer this feature.
The problem: Trailing stops require the investor or trader to pick the value whether % or price point and then that value stays fixed – it never changes! But the equities risk did not stay constant. So why should that value?
View example of how your typical broker's Trailing Stop works
- A stock is purchased for $50.00. Using a 10% trailing stop, when that stock closes below $45.00, it will automatically be sold. (10% of $50.00 = $5.00)
- If this stock went up to $60, the Trailing Stop moves up to $54.00, 10% below the new closing price. If the stock then closes below $54, it would auto-sell.
In this way, profits would be retained. The good news? As the price rises, the trailing stop rises with it, as it will always be a percentage of the price. The bad news? If the market price falls, the Trailing Stop price does not change. Which means you aren’t getting any adjustments for mild price corrections and get stopped out too soon.
The solution: The industry needed a smarter trailing stop. Which is why SmartStops created a superior proven approach to better protect your investments.
What Trailing Stop value is the best to protect your investment?
Should we use a one size fits all trailing stop? The answer is a resounding NO. Why? Because each stock or ETF has a different level of risk. Thus you need a trailing stop approach that factors in each stock’s specific risk profile or equity risk premium. And it’s more then just volatility. That’s why SmartStops was invented. And to grow your investments safely, you need to learn to hold on to your winners longer than your losers. Would you believe studies like the one by behavioral-finance professor Terrance Odean of the University of California, Berkeley, show that individual investors are 50% more likely to sell a winning stock than a loser—even though, on average, the stocks these investors sell go on to outperform while those they hold onto underperform. A trailing stop that can adjust both up & down as well as intelligently contracts or expands, provides the ability to “let your winners run.” The goal with a trailing stop is eliminate any emotional decisions which may drive you to let go of your winners to soon and fall into the trap of hope and prayer when the stock or etf is going down. And that’s what SmartStops will do for you. When we developed the Smart(R) risk optimization engine, we did it with 40 years of real world experience in the subject matter of exit strategies and studies of when to sell a stock or ETF. Sure, PhD’s like to hypothesize on their theories, but it takes real world practical application to know what works best.
“ I tried using trailing stops and kept getting stopped out too soon. The thing I learned is that trailing stops weren’t smart enough to adjust the way I needed them to… You saved me over $20,000 with Chipolte! …”
– Dan M.
What’s wrong with current trailing stop approaches?
A lot. Let’s take a percentage trailing stop for example. If you start at 8% (as Investor’s Business Daily likes to suggest), then when should it change? Should it always remain at that 8%? Or do you need to then become a chart technician and constantly be monitoring and charting to determine out of the thousands of technical analysis studies out there when to change it?
Or, if you start at 25% or some other value that newsletter stock publishers suggest, don’t be surprised to find that way too wide given the price movement of that symbol. It’s insufficient and too random a variable to just use a fixed percentage value of the stock or etf’s price. And other methods of technical analysis (Moving Averages, MACD, Parabolic, Volatility) have proven limiting as well. To learn more on that, see our Why We’re Better page.
The Smart(R) Approach
Our Smart(R) methodology is a much more sophisticated (though easy-to-use) approach, as it is pre-determining an intelligent trailing price point by tracking the macro trends of the stock market as well as examining the individual factors that have most significance in the equity’s risk profile. Plus, it adjusts both up and down making it help you stay in the trend longer! Building upon that, we also use different set of strategies for our optimization process, based on proven criteria used by even the big institutions in the industry.
What Makes SmartStops so Powerful?
The beauty of the Smart(R) approach is that it continually adjusts to give room for the stock or etf price to run. In other words, if using SmartStops as a continual smart trailing stop order for your positions, you won’t be stopped out too soon. And if just following our Risk Alerts, you will only receive a risk alert when there is strong probability of future decline.
Why do you have both an Aggressive and a Conservative SmartStop?
Smartstops recognizes there are different kinds of participants in the stock market. Some are more active traders while others are longer-term investors. To serve both effectively we designed our systematic risk approach to provide for a more “Aggressive” SmartStop which provides the maximum downside protection and typically lies closer to the equities price. Whereas the “Conservative” SmartStop allows more more price fluctuation resulting in few trades and less potential whipsaw. MOST IMPORTANT – Both signal families intelligently adjust in an effort to keep you in an uptrend longer while exiting early in a prolonged downtrend. As the infamous Howard Marks (Co-Founder Oaktree Capital Management) states:
“The road to long-term investment success runs through risk control more than aggressiveness. Skillful risk control is the mark of the superior investor.”
The most important thing to successful investing is controlling risk which is unavoidable if you want to participate in the stock markets. Remember that the amount and size of your investment losses will have more to do with your returns than the magnitude of the winners.