Why SmartStops is the Smarter, Better, Safer Choice
Today’s investing climate demands a faster, smarter, more sophisticated approach to Risk Assessment.
SmartStops next-generation risk-management analytics provides potent protection for your hard-earned capital. Built by experts with over 40+ year of real market experience SmartStops puts the best risk management expertise right at your fingertips.
Let’s take a look at some of the common investing approaches that you may have been taught to help you manage risk in the stock market. Unfortunately in today’s markets, these methods just aren’t smart enough to do the best job in allowing you to reach your earnings potential:
Gurus will tell you, don’t get left behind. Take advantage of technological advances.
Andrew Lo, MIT professor and author of “Adaptive Markets” said it best when he stated: “If you don’t have these [smart trading] tools, you are on the outside, unable to take advantage of technological advances. It’s “complex algorithms (that) allow investors to be more sophisticated and subtle.”
Buy & Hold
Skipping over the worst days of the market produces much higher returns.
Learn why »
Better than Trailing Stops
You need a loss protection plan, but choose a much smarter one than this.
Learn why »
Why “Buy & Hold” no longer holds up
Modern Portfolio Theory, or MPT, was developed in 1952 by Harry Markowitz. It theorized that investors could reduce their risk and maximize returns through diversification. MPT was built on the Efficient Market Hypothesis, which has since evolved significantly. MPT and PMPT (Post-Modern Portfolio Theory) state that price volatility (risk) will even-out over the long-term when one has a diversified portfolio of high-quality stocks. In short, hold stocks long enough and you will make a profit.
This is propagated throughout literature on stock investing strategies, teaching investors to hold firm through market ups and downs because, as “Buy & Hold” sees it, temporary dips won’t affect their portfolio’s overall value.
Worse still is that the industry reinforces the notion that, if you miss the ’best days’, you’ll lose out on the best deals, a notion blown apart by this 3rd-party study.
It’s also a self-serving claim, as the industry doesn’t want to see cash outflows, only inflows. It also forgets the fact that market corrections occur often, even in a bull market, forcing investors to give back a lot of what they’ve gained.
The Table below is the most critical. The table shows the actual point gain and point loss for each period. As you will note, there are periods when the entire previous point gains have been either entirely, or almost entriely, destroyed.
The Many Problems with Buy & Hold
The truth is that, too often, Buy & Hold is used as the default strategy, because a more effective strategy was never devised at the start. Why? Lack of time, resources and experience on the part of the investor.
Funds are tied up, long-term, and so unable to be used for other, possibly better opportunities.
Your Investment Horizon may not be long enough to ride out a down market
There are times when a stock should definitely be sold – but without mitigating risk properly, these opportunity windows can be missed
Emotion plays a large role in decision making, which is never a good thing
You Can’t Go Broke by Taking a Profit
Buy & Hold can create a situation known as ‘asymmetry of losses’, whereby the bigger the loss, the higher the gain is required to make up for that loss, damaging your earning power even further.
Opportunity Cost – What it Costs you to just “Hold”
And then of course, Buy & Hold completely overlooks the “opportunity cost” of having your money tied up while hoping the market recovers vs. having invested in better, more viable opportunities. Ask yourself; Do you have 11, 16, 17+ years for your investment monies to not be generating returns for you?
Shortfalls of following Analyst or Broker Recommendations
For those looking at the fundamentals to determine their investment choices, and utilizing analysis and recommendations from industry analysts, brokers or newsletter pickers, it’s important to realize some inherent truths surrounding them:
1. The ‘sell’ side of stock analysis is a much lower percentage than the ‘buy’ side, increasing risk substantially. See: The Truth Behind Analysts Ratings
3. Industry newsletters and analysts and brokers are notoriously “late” with their sell opinions, meaning investors get notified AFTER a big move has occurred.
Yesterday’s Strategy Does Not Fit today’s Globalized, Volatile Market
In the early 1990’s the internet fueled an explosive growth of online brokers, many of whom developed new tools to help individual investors and traders limit their losses without limiting gains. One of the best approaches brokers offered were Trailing Stops, or Trailing Stop Losses.
The theory behind a Trailing Stop is simple; a value, either a percentage or fixed dollar amount, is set and, when that value is reached (due to a stock’s drop in price), the decision to sell is automatically made.
The theory is that, when emotion is taken out of the equation, profits and capital are better protected. This is true!
BUT. Trailing Stops require the investor or trader to pick the sell position value and, if they want to change it, manually re-enter a new value.
Learn more about Trailing Stops
Trailing Stops – Good in Theory, Bad in Real World Scenarios
Trailing Stops, in their current form, have a number of limitations that make them unsuitable for today’s fast-changing markets.
- They only adjust in 1 direction – UP. They do not change when the market, trends or volatility changes, which often results in the whipsaw effect and premature exits.
- They only follow price movements, which is far too simplistic to reflect the proper equity risk premium
- As prices climb, percentage trailing stops move too far away from the price and fail to protect profits. For example, a 10% exit on a $10 stock is not the same as a 10% exit on $100 or $200 stock. (See example graph)
The Million Dollar Question; At what percentage should a Trailing Stop be set?
Investor’s Business Daily suggests starting at 8%. Stock Newsletter publishers, such as Stansberry, Navellier etc. offer recommendations that are either very unsophisticated (like use a 25% trailing stop loss) or non-existent, as you await when they say to sell – which by the way, they are notoriously late to issue that call.
Moreover, some of these businesses then ask thousands of dollars to teach you how to read charts, a significant investment of your time to both learn and constantly be charting to determine a stop loss price point. (It’s a never-ending learning curve.)
Using Technical Analysis or Charting Tools
Now, learning to read charts might interest some who are doing more active trading. Still however, the amount of time dedicated to learning, experimenting and then maintaining is like a part-time job. For the majority of investors and traders, it can quickly become overwhelming trying to figure out just which technical analysis studies to use, in what combination, and with what variables (i.e. Moving averages could be 10 over 20 days, 20 over 50 etc.)
Some of the most common Technical Analysis (TA) approaches taught include:
The question then start flowing:
- Which one should I use?
- Does one work better than another?
- Should I adjust the factors within the study?
- Should I use a specific combination of studies?
It’s important to realize some of the pitfalls with these approaches. Let’s highlight a few:
1. Moving Averages
- Too many choices:
- Which value is the best? 10, 20, 30, 50, 100 days?
- Should I use it alone or as crossovers (i.e. sell when 20 day MA crosses over 50)
2. Support and Trend lines
- Time frames of charts chosen (30, 60, 90 min vs. daily or weekly etc.) will affect price patterns and thus the support or trend lines drawn.
- If a stock accelerates rapidly the support level remains in place often lagging too far behind prices.
- In the case of a down trending market that is making new lows, there is no discernible support on the chart. If you were entering a new position or holding an old one as new lows are made, what would you use to identify further downside risk?
- Support can be found at trend lines, previous lows, pivot points, fibonacci retracement levels and numerous chart patterns – it’s more art than science.
- In a sideways market, trend lines will be subject to frequent whipsaws.
- When the stock market goes up one day, and then goes down for the next five, then up again, and then down again, that’s what you call stock market volatility. In layman’s terms, volatility is like car insurance premiums that go up along with the likelihood of risky situations. It’s mathematically defined as the degree of variation of a trading price series over time as measured by the standard deviation of logarithmic returns. But as pointed out by investment experts like Howard Marks (Oaktree Capital Mgmt)
“… knowingly or unknowingly – academicians settled on volatility as the proxy for risk as a matter of convenience. They needed a number for their calculations that was objective and could be ascertained historically and extrapolated into the future.Volatility fit the bill… Yet while volatility is quantifiable and machinable… it falls far short as “the” definition of investment risk”.
- Just think about this – Say a stock that has climbed slowly and steadily for years and accordingly has a relatively low beta but not it might sell at an astronomical multiple to revenue or earnings. A risk-averse, beta-focused investor is happy to add the stock to his diversified portfolio, while demanding relatively small expected upside, because of the stock’s consistent track record and low volatility. But a fundamentally-inclined investor might consider the stock a high risk investment, even in a diversified portfolio, due to its valuation. There’s a tradeoff between risk and return, but volatility and return shouldn’t necessarily have this same relationship.
- We know of other services that claim volatility is the key ingredient. It is important for traders and investors to properly educate themselves, so we highlight here what many industry experts think about just using volatility as your risk measurement. Like this quote: “How can professors spread this [nonsense that a stock’s volatility is a measure or risk]? I’ve been waiting for this craziness to end for decades. It’s been dented, but it’s still out there” – Charlie Munger
- Beta is a measure of a stock’s volatility in relation to the market. High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stocks pose less risk but also lower returns.
- Is there a problem with Beta?
It assumes the upside potential and downside risk of any investment are essentially equal, being simply a function of that investment’s volatility compared with that of the market as a whole. More recently in Post Modern Portfolio Theory, the Sortino factor was introduced; as it was recognized that it’s actually only downside volatility that can a useful measurement to risk. However – services that just uses Volatility , like the Volatility quotient (used by Tradestops) or Beta or the Sortino factor are still not comprehensive enough approaches.Today’s 21st century stock market investors and traders deserve more!
A Smarter Approach for Risk Protection in the 21st Century Stock Market
What is Needed
Look at this chart to the left. What has been missing until now – is a Smart Trailing Stop that knows how to:
- Adjust up & down
- Expand and widen
- Accounts for both macro market conditions and individual equity trends for optimization
Learn more about the Smart(R) optimization engine that powers our Smarter Trailing Stop.
There are many investors however who simply don’t want an automatic “sell” signal to exit out positions. And that’s ok. That’s why SmartStops built its Risk Alerting service.
This service allows you to have your portfolio continually monitored and instant Risk Alerts sent to your email and/or phone, but only when Risk is in an Elevated State.
Then, you can review the position, reassess the risks, make an informed decision and take timely, protective action.
In closing, SmartStops is the 21st century stock and ETF investing solution. It’s extremely flexible, easy to use, takes the emotion out of your decisions and, most importantly, allows you to instantly know when to hold ‘em, and know when to fold ‘em.