Finally! Foolproof Investing
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
- Mark Twain
Is there such a thing as a foolproof investing system?
After nearly 20 years of research and first-hand experience, I believe that I finally have an answer…
There’s a saying at the poker tables of the world, “If you don’t know who the sucker is, then it’s probably you.”
It didn’t take me long in my investing career to figure out that I was the sucker. What I found amazing is how long it took me to figure out how to not be the sucker.
I had been at least moderately successful at most things I’d tried in life – except investing (and selling encyclopedias one summer). I was accustomed to winning at most things. So why was I always losing at investing?
Eventually I figured it out. Investing is a rigged game.
There are the obvious riggings – like financial advisors charging excessive fees, brokers churning accounts to generate commissions, Madoff-style Ponzi schemes, rampant insider trading and high frequency spoofed trades.
But, with apologies to J.R.R. Tolkien, there’s one rig that rules them all – financial markets are rigged against human nature. As Benjamin Graham famously said, “The investor’s chief problem – even his worst enemy – is likely to be himself.”
Graham, much like myself, was speaking from first-hand experience.
There are, of course, legitimate market functions such as capital formation and allocation. I estimate that these legitimate functions make up maybe 10% of market activity – and that’s being generous. The other 90% is smoke and mirrors intended to distract the suckers while their pockets are picked in every way imaginable.
While preparing for a presentation I’m giving this week, I was looking up information on behavioral finance. I am already well aware of the major behavioral biases of investing – things like regret avoidance (not selling losers to avoid regret), recency bias (overweighting recent information) and overconfidence (see Mark Twain quote above).
What I was astonished to find, however, is a list on Wikipedia of 170 known and documented cognitive biases! As I read through the list, it seemed to me that at least half of them were relevant to investing. Feel free to check out the list for yourself here .
Is it any wonder investing is difficult? (If anyone has an hour to spare, there’s a fantastic talk on YouTube by Charlie Munger, Warren Buffett’s partner, on The Psychology of Human Misjudgment.)
All of this is to say that investing ain’t easy – and there are deep reasons why this is so.
The good news is, all of this can be overcome – for a cost. We have to give up “what we know for sure that just ain’t so.” We have to acknowledge the fundamental uncertainty of investing – and embrace it.
That’s the basis of the “foolproof investing system” that I’ve been working on for the past 15 years. It is “foolproof” in the sense that it’s “proofed against fools” – and yes, I count myself amongst the fools.
As Robert Cialdini says in his book Influence: The Psychology of Persuasion, “I can admit it freely now. All my life I’ve been a patsy.”
Just as Cialdini researched the psychology of compliance in order to better understand it and to defend himself against mass media “compliance practitioners,” I’ve put together my investing system to protect myself and others from the market riggings.
So, without further ado, I present to you my “10 Steps to Foolproof Investing”:
- Find a source of good investment ideas. If you don’t currently have a source of good investment ideas, there are numerous outstanding low-cost financial newsletters available today that are chock full of good investment ideas. A few such newsletters that I have first-hand experience with (and have personally back-tested) are:
- True Wealth by Dr. Steve Sjuggerud,
- Stansberry Investment Advisory by Porter Stansberry
- Oxford Club Communique by The Oxford Club
- Capital & Crisis by Chris Mayer; and
- Retirement Millionaire by David “Doc” Eifrig
- Palm Beach Letter by Tom Dyson and Mark Ford
- Look for investments that have an active Smart Trailing Stop status. These investments are still in uptrends (per my Smart Moving Average) and have not corrected beyond their normal expected volatility range.
- [Optional]: Look for investments that have pulled back into their Low Risk Buy Zone.
- Invest in 10 to 15 different stocks and funds.
- Risk 1% of your capital on each position. It’s okay to double down (risk 2% of your capital) on a couple of low risk / high conviction opportunities.
- Position size for equal risk using my Volatility Quotient indicator as the measure of risk.
- Don’t put all of your eggs in one basket.
- Keep your average Volatility Quotient below 20%.
- Exit when your Smart Trailing Stop is hit and congratulate yourself for doing so.
- Look for a new investment idea or wait for a re-entry trigger and always remember, capital is finite… opportunity is infinite.
I know that just looking at this written list of “10 steps” might not look all that “foolproof” but I’m not just giving you a list. I’m giving you the tools to follow this script – all of the tools. In fact, most all of these tools are already available to subscribers of TradeStops.com and the last couple of remaining items will be available within the next month.
I’m going to be going over all of this in a lot more detail in the coming weeks and months, so don’t worry if it isn’t jumping off of the page at you right away.
Finally, I know that there are other viable solutions out there to the “investor’s dilemma.” But I designed the 10 Steps to Foolproof Investing with a few unique things in mind.
- Anyone can do it.
- The annual cost of the tools and information sources is less then $50/mo.
- It leverages the advantages that we have as self-directed investors and gives us a chance to separate ourselves from the investing herd and beat the markets.
- It puts you in the driver’s seat and makes investing the fun and prosperous adventure that it was meant to be.
To the growth of your wealth,
Richard M. Smith, PhD
What Do You Mean I’m Already Stopped Out?
“What do you mean I’m already stopped out?”
This is, far and away, the biggest question we’re getting since we released Smart Trailing Stops 2.0 (STS 2.0). I understand the question.
I know that STS 2.0 is different than what long-term-trailing-stops users are accustomed with. It’s really different to use an automatically-detected high price from the past rather than using your entry date and entry price as the initial point from which to trail the stop. It leads to all sorts of new questions.
I also think that it’s a huge advance and I’m going to show you why I set it up this way, and share some suggestions about how to deal with stocks that are “stopped out” sooner than you’re used to.
But first, let me show you what I’m talking about.
Following the launch of our new STS 2.0 algorithm, we added a simple interface to easily convert STS 1.0 stops to the updated STS 2.0 algorithm. Here’s a sample from a TradeStops account:
In the case of WMT here, the STS 1.0 alert had a Current Stop Price of $76.89 while the STS 2.0 alert had a New STS Price of $79.84. The Latest Close on WMT as of this writing was $77.88. So the STS 2.0 alert is stopped out but the STS 1.0 alert is not yet stopped out.
Here’s how it looks on a chart of WMT:
Even though both the STS 1.0 and the STS 2.0 use the same percentage stop of 11.2%, the STS 2.0 alert is stopped out while the STS 1.0 alert is not yet stopped out. How come?
The difference is that the STS 2.0 alert is trailing the stop from the automatically-detected high close of $89.93, whereas the STS 1.0 alert was trailing the stop from a more recent high of $85.52.
Clear so far?
Let me share with you an even more dramatic example.
In the video available on TradeStops.com in which I introduce STS 2.0, I share this chart of GDXJ, the ETF of junior gold miners:
The above chart shows how GDXJ made a significant high of $45.19 in July of 2014. At the time, the Volatility Quotient, or VQ, on GDXJ was 39%. GDXJ corrected more than 39% from its July 2014 high and was stopped out in late October 2014.
Here’s the thing… if you go to put a Smart Trailing Stop on GDXJ today, you’ll get the message that GDXJ is Stopped Out.
Huh? How could a stock be stopped out when you don’t even own it? What exactly does that mean? Does it mean that you shouldn’t buy the stock?
First of all, if a stock is showing as Stopped Out per STS 2.0, it literally means that the stock has already corrected by more than it was expected to correct in the normal course of business. It means that it has moved further than VQ% from the recent high close as detected by the STS 2.0 algorithm.
In the case of GDXJ, the stock moved down more than 39% from its significant high of $45.19. The Smart Trailing Stop price on GDXJ was $27.57. GDXJ was stopped out when it closed below $27.57 on October 30, 2014. Moreover, with STS 2.0, once a stock is stopped out it stays stopped out until it proves itself again by triggering a new Re-Entry Rule.
I know that this is a bit different than what many of us are used to when we think about trailing stops but I did it this way on purpose. I did it this way because I believe that it delivers the best value to TradeStops subscribers. I did it this way because my research showed that this method delivers the best results.
Smart Trailing Stops have always been based upon the concept of the normal expected volatility range for a stock – what we now call the Volatility Quotient or VQ of the stock. Smart Trailing Stops 2.0 introduced the additional benefit of automatically identifying the best high closing price from which to trail the stop.
That’s why, like we saw with GDXJ, a stock can sometimes already be stopped out by the STS 2.0 algorithm, even if you’ve just bought the stock.
Now then, just because a stock has a current STS 2.0 status of Stopped Out does that mean you shouldn’t ever buy it? No, that’s not what it means. A STS 2.0 status of Stopped Out is just telling you that the stock has already corrected more than what would normally be expected of the stock.
This is valuable information! If you have a good reason for buying or holding the stock, then by all means, please do so. But the fact that the STS 2.0 algorithm has stopped out of this stock is information that you should definitely consider.
You should consider it a big red flag on the stock. The stock is not behaving normally. It has recently suffered a relatively severe correction. Dogs that bite once often bite again.
Believe me, I know how tempting it is to look at a stock like GDXJ and say, “It’s already down 40% since July 2014… How much lower could it go? I’m going to buy it now while it’s cheap.”
I’ve done it myself… more times than I care to admit!
Let me show you something that I think you might find a bit shocking. I’d like to show you how many times GDXJ has fallen 40% since April of 2011.
In April 2011, GDXJ made a high of $150.04. Just 8 months later, in December 2011, GDXJ had fallen 40% to $88.34. Was it now a bargain?
Well, it did rally briefly but by April of 2013, GDXJ had completed another 40% fall from $88.34 to $53.04 by April 15, 2013.
Surely, now GDXJ was a bargain, right?
Well, by December 2014, GDXJ had completed yet another 40% correction when it closed at $21.31.
Here’s how all that looks on a chart.
Each shaded area represents a drop of 40% from the price at the beginning of the shaded area to the price at the end of the shaded area.
I’m sure that some of you by now are really itching to buy GDXJ after it’s fallen so far. I know because I can feel it tugging at me!
Do you think that it’s unlikely that GDXJ will fall yet another 40%? I wouldn’t be so sure. A 40% correction from $21.31 is only down to $12.79. That’s less than $9 from where we are today!
Now again, all of this isn’t to say that you shouldn’t buy GDXJ. It’s just a huge red flag – exactly the kind of red flag that Smart Trailing Stops 2.0 was designed to bring to our attention.
So, assuming that you have decided to buy GDXJ, how can you best manage your risk in GDXJ since the Smart Trailing Stop on it is currently Stopped Out?
You’ve got a few options:
- Don’t buy the stock yet or sell it if you already own it. My best algorithm is telling you that this stock has a severe storm warning on it. If you’ve got a good reason to still buy or hold onto the stock, then please proceed, but proceed with caution.
- If you’re following a newsletter recommendation, then use the recommended strategy of your newsletter editor.
- Use a simple percentage trailing stop of your choice –25%, 35%, 45%–whatever you want.
- Check the current VQ% on GDXJ and use a trailing stop at that level. The current VQ% on GDXJ is 41.6%. So you could set a simple trailing stop of 41.6%.
- Control your risk by limiting your position size. You could even go as far as not using any stop loss at all as long as you only put as much money into GDXJ as you’re willing to lose completely!
- Limit your risk with options. For example, you could strictly limit your risk by buying some call options on GDXJ. You could buy the November 2015 $30 call options currently for $1.75. That means that for $175 you have the right to buy 100 shares of GDXJ at $30. If GDXJ soars 100% from here in the next 6 months, then those call options will be worth nearly $2,000. If GDXJ goes nowhere or falls even further, you’re only out $175.
My personal strategy on GDXJ would be to wait for the Re-Entry Rule to trigger and then look for an entry point on a pull back into the Low Risk Buy Zone. (These features will be available in TradeStops Pro by the end of May.)
I’m not giving you all these choices to overwhelm you. I just want you to really understand two things:
- The Smart Trailing Stop on GDXJ is currently “stopped out” and this is a red flag on the stock. It is telling you that the stock has already corrected more than should have been expected of normal corrections. If you’re going to stay in or get into the stock, be cautious.
- There are lots of other ways that you can still buy GDXJ and intelligently manage risk even though the Smart Trailing Stop is currently stopped out.
I know that a lot of you look to TradeStops to just “do it for me.” I know that STS 2.0 is a little different than the way that we’ve done things before.
I do want you to understand that a Stopped-Out status of my STS 2.0 algorithm is an important piece of information that I want you to be aware of. I also want you to know that I am working on several ways for you to easily and automatically apply a default alternative strategy to those stocks where the STS 2.0 is currently stopped out.
That’s all for now.
To the growth of your wealth,
Richard M. Smith, PhD
We’ve covered a lot of ground in the last two months – position sizing for equal risk, Smart Trailing Stops 2.0, Volatility Quotients, Low-Risk Buy Zones, Smart Moving Averages and Re-Entry Rules.
Now it’s time to put all the pieces of the puzzle together into what I call the new TradeStops Profit-Maximizing System.
This information is a bit more advanced than most, but this is how I use these tools myself and I wanted to share it with you.
I’ve kept it as simple as possible and included clear charts. If you find the material a little challenging, just remember that you can easily accomplish all of this using the TradeStops tools (or at least you will be able to by May 2015).
Let’s take a look at the past 7 years of Johnson & Johnson and assume that we were interested in getting long JNJ after the 2007 – 2008 market correction.
The Volatility Quotient on JNJ in early 2009 was about 15%. So to use our Re-Entry Rule we would have been waiting for a bounce of greater than 15% off of a bottom and for our Smart Moving Average to start to turn up.
That happened on August 21, 2009.
If we were willing to risk $1,000 on JNJ at that time and our Smart Trailing Stop risk was 15% then we could have invested about $6,667 in JNJ (that’s $1,000 / 15%). At a cost of $51.03 per share that means that we could have purchased 130 shares of JNJ (that’s $6,667 / $51.03).
Using a Smart Trailing Stop would have kept us in this leg of the JNJ trade for five and a half years – all the way until the stop was finally triggered on October 13, 2014 at $96.21.
So, over that five and a half year period we made $43.18 per share on each of our 130 shares for a total profit of $5,613.40.
If we just focus on the percentage gain of our entire investment then we made a gain of about 84%.
However, remember that we only risked $1,000. If we look at the ratio of our Reward to our Risk we made $5,613 on our $1,000 of risk. That’s an excellent reward-to-risk ratio of 5.6 to 1.
Now admittedly, it was a pretty darn tough exit on JNJ in October of 2014. The stock made a very unusual sharp V-shaped bottom. In fact, JNJ only spent a single day below the Smart Trailing Stop and then immediately reversed course and rocketed back up. That’s about as frustrating as it gets. (Short aside – isn’t it amazing that even when we win, it can still feel like we lost?)
But remember, we’ve got some new arrows in our quiver now with our Re-Entry Rule and our Low-Risk Buy Zone indicators.
Let’s zoom in on the last 8 months of JNJ to see how we might have leveraged these tools.
At the time that JNJ was stopped out in early October 2014, the Volatility Quotient on JNJ was right at 10%. Our Smart Moving Average was still trending up, so as soon as JNJ rose 10% off of its October bottom, it triggered a Re-Entry Rule in early November 2014.
The Re-Entry Rule trigger activated a new Smart Trailing Stop, about 10% below the new entry price. The new Smart Trailing Stop is shown in green on the chart above.
Now maybe we were feeling a little gun shy about jumping right back into JNJ after such a violent “wash and rinse” move that stopped us out of our original Smart Trailing Stop.
If we weren’t prepared to take the full 10% risk on JNJ at the time of the re-entry trigger, we could have decided to wait for JNJ to pull back into its Low-Risk Buy Zone. Remember, the Low-Risk Buy Zone is triggered when price pulls back about 60% of the way to the current Smart Trailing Stop.
That happened on January 20, 2015 when JNJ closed at $100.59.
Now here’s where you’re really going to think I’m crazy (or see the power of this approach).
On January 20, 2015, the Smart Trailing Stop on JNJ sat at $96.94. With an entry price of $100.59 and a stop price of $96.94 that means that we were only risking $3.65 per share. That means that our risk is just 3.6%.
If we’re willing to risk $1,000 on a new position in JNJ and we only have to risk 3.6% per share, how much we can we invest in JNJ? You can use the TradeStops Position Size Calculator to figure this out but the answer is an astonishing $27,559!
Why on earth can we invest $27,559 in JNJ at this point? Because if our hefty position in JNJ corrects just 3.6%, we will have once again triggered the Smart Trailing Stop and will be out of the trade with our small loss of just $1,000.
A 3.6% loss on a $27,559 position is just $1,000. Pretty amazing, isn’t it?
I know that all of this is just a little bit complicated, but the fact of the matter is you can accomplish all of this simply and easily using the tools that we’ve built in TradeStops.com.
Last week we released the new Smart Trailing Stops 2.0 algorithm and Volatility Quotient in TradeStops. In the next few weeks we’ll be adding the Low-Risk Buy Zone, Smart Moving Averages and Re-Entry Rule indicators to TradeStops Pro.
Now is the time to be on board. TradeStops gives you the tools you need to know your risk and to make that risk work for you instead of against you.
To the growth of your wealth,
Richard M. Smith, PhD
When to Get Back In
“When should I get back after I’ve been stopped out?”
It’s a question that anyone who ever uses trailing stops is bound to ask.
Finally, I’ve worked out a solution.
There’s a lot of math involved but in a nutshell, here’s how it works:
- Make sure that the trend is with you;
- Wait for a strong move in your direction that exceeds the normal volatility range of the stock;
Here’s how that looked on the S&P 500 following the 2007 – 2009 bear market:
The two key features of the above chart are the new Smart Moving Average, which I’ll tell you more about in just a minute, and the Volatility Quotient (VQ%).
The Smart Moving Average tells us the trend. The Volatility Quotient tells us how strong the move needs to be in order for us to be confident that a bottom is in place.
There’s something really important to note in the above chart.
At the time of the bottom in the S&P 500 in March of 2009, the Volatility Quotient on the index was 20.9%. If we had just waited for an up move that was greater than the bear market VQ%, then we would have gotten long at around 840.
Our new Re-Entry Rule, however, didn’t trigger until the S&P 500 had risen a full 48% off of its low. Waiting for our Smart Moving Average signal to also trigger, kept us on the sidelines until the index reached about 1,000.
Now I realize that, in this case, it would have been nicer to get long the S&P 500 around 840 rather than wait until the 1,000 level but I chose this example because I want you to understand how important I believe it is to not fight the trend.
One of my favorite market maxims is “Opportunity is infinite; capital is finite.” There are sooooo many opportunities in the financial markets to put our money to work that it’s just silly to constantly try to jump the gun on new trends.
As investors in the market batter’s box, we’ve got to wait for the fat pitch.
Why? Because when the right pitch comes, you can hit homeruns – like this:
These are the kinds of moves that my entire investment philosophy – and all of the tools that I’ve built – are designed to capture. These are the kinds of moves that I believe that YOU need to capture as an investor in order to be successful.
That’s why I created my new Smart Moving Average indicator… and why I use it as primary component of my new Re-Entry Rule strategy. That’s why I’ll soon be adding it to the arsenal of market-beating weapons available to my TradeStops subscribers.
What exactly is my new Smart Moving Average indicator? Let me explain.
My short hand for Smart Moving Average is SmMA (so as not to confuse it with an SMA or Simple Moving Average).
The math behind the SmMA is complex but the concept is simple – find the moving average that was:
- The best support for longer term trends; and
- That provided the biggest bounces when price came down to touch support.
We use about six years of historical data when computing the SmMA and, as always, we’re looking for indications that help us to stay invested for at least six months to a year or more. We also give recent data more weight in order to catch market turning points a bit sooner.
The current SmMA on the S&P 500 is 197 days. You can see on the following chart the this 197 day weighted moving average has done a great job of supporting longer term trends – in both bull and bear markets.
Now that you know a little bit about how the new SmMA works, let’s take a look at how our new Re-Entry Rule worked on the S&P 500 over the past 40 years.
The following chart shows all of the Re-Entry Rule triggers along with Smart Trailing Stop exits on the S&P 500 from 1974 to 2015:
Here is a table showing the details of all of these trades:
All in all, there were 15 such trades over a 40 year period and 12 out of the 15 trades were profitable with average gains of nearly 20%. Moreover, there were some very large winners of 40%, 65% and 105% while the three losers were all less than 10%.
That works for me!
Here’s another way to look at it.
The following chart shows what would have happened if you had used my Re-Entry Rule strategy on all of the individual stocks in the S&P 500 vs. just buying and holding the S&P 500 itself. The vertical axis here shows how many dollars of profit were made for each dollar of risk taken.
Over the last 20 years you earned a bit more per dollar of risk taken if you bought and held the index but you took a lot more risk in order to do so! The Re-Entry Rule strategy perfectly threaded the needle between the extreme highs and lows of the broad US stock market.
Now remember, we’re not looking to this new Re-Entry Rule to be our only way of buying into the market. We’re looking for a solid and robust indicator of when we can buy back into an investment that we’ve been stopped out of but that we still love.
As such, we’re looking for something very stable… and very reliable. We’re looking for strategies that maximize our returns and minimize our market stress.
As with nearly everything I do, I’m looking for ways to tame the wild-eyed frenzied investing beast within who always seems to be fretting or frothing over something.
One of the biggest psychological hurdles of using trailing stops is that our stops will be triggered and the inner investing beast will shout, “If I exit here, it might turn right back around and start going up again!”
Keeping my new Re-Entry Rule in your back pocket will allow cooler heads to prevail and reply, “That’s true, but we can always get back if and when the Re-Entry Rule is triggered.”
Next week I’m going to share with you how we can put all of these new tools together into a powerful new profit maximizing (and stress minimizing) system.
To the growth of your wealth… and your peace of mind,
Richard M. Smith, PhD
Founder & CEO, TradeStops.com
This Changes Everything
I might have to change the name of TradeStops after I’m done with this one.
You know by now that I believe successful investing is more about how you manage your investments than it is about which investments you make.
TradeStops has been focused on helping investors know when to sell to maximize profits and minimize risk as well as how much money to put into different investments, a.k.a. position sizing, in order to tune risk to one’s personal risk comfort zone.
Last week I showed you some simple ways that TradeStops could be used to be more proactive about how and when we buy our investments as well.
What I’ve got to share with you this week, however, changes everything.
The first new buy‐side indicator that I would like to share with you is what I call the Low‐Risk Buy Zone.
I recently shared with you how our newest, most advanced, Smart Trailing Stop strategy has three components
- Automatically-detected recent high
- Volatility Quotient
- Smart Trailing Stop price
Here’s how it looks on the example of TSLA that we’ve looked at recently:
(Note: the small uptick in the Smart Trailing Stop price line in the chart above is from the stop level automatically tightening up as the volatility in TSLA shrinks.)
The most important point to note here is that, with this new algorithm, the Smart Trailing Stop price remains the same, even if you buy TSLA today. That’s because the new algorithm automatically detects the high price from which to trail the stop instead of just using your entry price as the initial high price.
The current Smart Trailing Stop price on TSLA is $171. As of this writing, TSLA is currently sitting at $185.00.
If you bought TSLA today, and you use my newest algorithm, then your current risk on TSLA is only $185 ‐ $171 = $14.
On the other hand, if you had bought TSLA back in September of 2014 at the high of $285 then your risk was the full 40.0% Volatility Quotient. But if you buy TSLA today, you only have about 5% of that risk left.
Are you starting to get the idea of the Low Risk Buy Zone?
Using these new tools we can start to look for when a stock has pulled back far enough that it is close to its Smart Trailing Stop point but hasn’t crossed over it yet.
The question is, how much of a pullback should that be?
Letting a stock pull back as much TSLA has pulled back in the chart above is not likely to work out well very often. TSLA is a volatile stock and, at this point, it’s only about 5% above its Smart Trailing Stop price. TSLA could easily move 5% in one day. In fact it has done so over a dozen times in the past year alone.
It would be great if we could always wait until a stock we want to buy has pulled back to the very bottom of its VQ range but, unfortunately, that’s usually waiting a bit too long.
My research team and I performed extensive back‐testing on this question and we reached the conclusion that, on average, the best time to look for a Low‑Risk‑Buy‑Zone entry point is when a stock has pulled back a bit over half of its VQ range – 60% to be exact.
Taking a look at our TSLA example, that would mean that we could start looking to buy TSLA on a pullback of 24% or more (for the numerically interested that’s the 40% VQ times 60%).
Here’s how it looks on a chart:
By waiting for TSLA to pull back into its Low‐Risk Buy Zone, we could have reduced our risk in TSLA down to 16% instead of the full 40% ‐ if we were willing to wait.
As another illustration of this concept, the following chart shows the S&P 500 Index and highlights the half dozen or so times that the index has pulled back into its Low‐Risk Buy Zone since the 2009 bottom.
Each time that the price dipped below the blue line was an opportunity to buy the S&P 500 with minimal risk. Each time, thus far, the index bounced up out of the Low‐Risk Buy Zone without crossing the red Smart Trailing Stop price line.
I personally love the idea of the Low‐Risk Buy Zone because I love taking less risk. I’ve been using this strategy myself for about a year now and it’s been working very well for me.
I’m excited to soon be sharing it with my TradeStops subscribers.
I’ve introduced a lot of new concepts over the past month… and I still have one final new concept to cover. I was going to try to do that this week but I think that I’ll leave it to next week instead.
At this point I feel like I owe a bit of an explanation about when subscribers will be able to get access to all of these new tools that I’ve been seemingly teasing you about.
Here’s the approximate timeline of events for the next six weeks.
- Early April: Release of new Smart Trailing Stops 2.0 and introduction of the Volatility Quotient
- Mid-April: Introduction of Low-Risk Buy Zone alerts
- Early May: Release of new Re‐entry Rule – a brand new algorithm that tells you when to get back into a stock if the stock is currently stopped out
Wow. That’s a lot of new tools.
So… do you think that the name TradeStops is still an appropriate name for our expanded set of services? Maybe TradeStarts? TradeStopsAndStarts? How about TradeSmith?
Feel free to drop me a line and share your thoughts by just replying to this email.
To the growth of your wealth and your mastery of the markets,
Richard M. Smith, PhD
Founder & CEO, TradeStops.com
TradeStops Buy Signals
TradeStops is, of course, well known for helping investors know when to sell. Not many investors, however, understand the power of TradeStops to also help you know when to buy.
Today I’d like to share with you a few ways in which you can currently use TradeStops for buy–side decisions.
One of my personal favorite ways to use TradeStops to help me make buy decisions is to alert me when an asset that I’m interested in has bounced significantly off of a recent low price.
I’ve learned the hard way that catching falling knives is a tough business. So when I get tempted, I ask TradeStops to let me know when the knife has stopped falling and has started a significant rise.
I do this by setting simple percentage trailing stop alert on a stock position that is set up as if I had sold the stock short.
Short sellers profit when the price of a stock falls. Setting a trailing stop on a short position will alert you when the price rises since if you’re short a stock, you’re losing money if the price rises.
Let me show you what I mean.
Let’s say that you became “intrigued” by the 50% fall in the price of oil over a mere six months from June 2014 to December 2014.
We’ll use the iPath S&P GSCI oil ETF that tracks the price of West Texas Intermediate crude oil futures. The symbol for this ETF is, not surprisingly, OIL.
In June of 2014, OIL made a high around $26. By December 2014, it was trading for about $13.
In order to be more confident that a strong bottom had been put in after this shocking price rout, we might want to know when OIL had risen a solid 25% off of a bottom.
To be alerted to this situation by TradeStops we could set up a short position on OIL and set a 25% trailing stop on it. Here’s how that’s done.
- Create a manual Watch Only portfolio from the Portfolios page in TradeStops. Watch Only portfolios are manual portfolios for positions that you’re following, but aren’t yet invested in.
- Add a new position on OIL to this portfolio and set it up as a Short position with a 25% trailing stop.
That’s all there is to it. Again, short sellers of stocks profit when the price of a stock falls. So the maximum point of a profit in a short position is the lowest price of the stock since the entry date. A short position is losing money when the price of the stock rises.
Setting a 25% trailing stop will trigger an alert on a short position when the asset has bounced 25% off of its lowest price.. Here’s how that looks in a chart:
The blue line is the trailing stop line for our short position on OIL. Since our position on OIL is a short position, the trailing stop line is above the price. When OIL rises 25% off of a low, the trailing stop will be triggered and TradeStops will send an alert.
At today’s levels, that 25% trailing stop will be triggered if OIL closes above $11.80.
As I’ve mentioned many times before, I believe that a lot of success in investing comes from tricking ourselves into not doing certain things – like trying to catch falling knives, for example.
“The price of oil is down 50%! It’s a bargain! ISIS is terrorizing the Middle East… Iraq and Syria are falling apart… Iran’s going to get a bomb. Oil can’t go much lower than this. I’m buying!”
Been there… done that… don’t want to do it again.
It’s amazing how taking this simple action of setting up this watch–only alert in TradeStops satisfies the urge to “just do something” in the face of such urgent market temptations.
If you’re a TradeStops Pro subscriber, there are additional types of alerts that you can use to alert yourself to your preferred buy signals. Here are a few of them:
- Breakout Alerts alert you when a stock makes a new high over a given time period. Here, for example, we’ll be alerted if the stock closes at its highest point of the past 12 months:
- Close Above / Below alerts let you set a fixed price target at which to be alerted. Here we’ll be alerted if this stock closes above $72.00
- Moving Average alerts let you know when a stock closes above or below a moving average. Here we’ll be alerted if the price closes 1% above the 100–day moving average.
- Moving Average Crosses let you know when one moving average crosses another. Here we’ll be alerted if the 50 day moving average closes 1% above the 100–day moving average.
All of these alert types allow us to be more purposeful in our buying strategies. We can use them to let the markets come to us… to watch for the right pitch… to be proactive rather than reactive.
Next week I’ll share with you a couple of brand new buy–side indicators that I’ve developed, and that I’m very excited to be soon bringing to my TradeStops subscribers.
To the growth of your wealth,
Richard M. Smith, PhD
Founder & CEO, TradeStops.com
P.S. The response to my “Volatility Quotient” idea was overwhelmingly positive. Over 500 people replied to my inquiry and well over 95% of the replies were positive. I’ll be launching the new Volatility Quotient and Smart Trailing Stop tools in the first half of April.
My Volatility Quotient Can Make You Even More Money
I love it when we can reduce risk without reducing our chances of success. Don’t you?
Last week I shared with you the next evolutionary step in Smart Trailing Stops – how we can further reduce risk and maximize profits by automatically finding the best high close from which to trail our Smart Trailing Stop.
If you missed that article, you can find it here, but here’s the chart that sums up what we discussed last week:
In a nutshell, by trailing our Smart Trailing Stop on TSLA from the September high at $285 instead of from a November entry at $240 we would have further reduced our risk in Tesla by raising the initial stop loss point to about $167 instead of about $141.
Our new advanced Smart Trailing Stop algorithm automatically determines the best recent high from which to trail our stop.
As the Smart Trailing Stop algorithm evolves and matures, the way that I think about it and describe it is also changing.
And this brings me to something that I’d like your help with.
In the past I’ve used the term “Smart Trailing Stop” to describe the percentage value of the stop – for example, 41% on TSLA.
This description, however, doesn’t capture the full benefit of this percentage indicator. This percentage value is more than just a stop loss level. It tells you how much noise or wiggle room there is in the stock. This is valuable information whether you use a stop loss or not.
In addition to being used to identify an optimal trailing stop level, it can also be used to adjust position sizes for volatility so that we’re taking equal risk on our different investments instead of putting an equal amount of money into each investment.
I’ve come up with a new name that I think better captures the full scope of the benefits of this important indicator. I call it the Volatility Quotient or VQ.
We’re all familiar with Intelligence Quotients or IQ. Nowadays we even talk about Emotional Quotients or EQs.
In the same way that these two well–known quotients are intended to tell us something important about a person, I think that this Volatility Quotient tells us something very important about our investments.
Using this Volatility Quotient value helps us to get into our personal risk comfort zone in a number of ways – including what level of trailing stop to use.
If we’re going to start saying that, for example, “The Volatility Quotient on TSLA is 41%” then where does that leave us with the term Smart Trailing Stop?
Well, as I see it, the term Smart Trailing Stop best describes the actual stop price itself – in this case, $171 on TSLA.
Using these refined terms we would say, “The Volatility Quotient on TSLA is 41% and the Smart Trailing Stop is at $171.”
It makes sense to me but what’s most important is that it makes sense to you too.
I’ve always tried to keep it simple in TradeStops. That’s super important to me.
I think that this idea of “Volatility Quotient” adds value to TradeStops. It’s a figure that tells you something meaningful about the stock all by itself.
But I want to hear from you on this issue as well. I don’t want to unnecessarily complicate things.
So please do me a favor…hit reply to this email and just tell me “Yes” if you like my new Volatility Quotient idea or “No” if you think that I’m muddying the waters unnecessarily.
Feel free to tell me more than just “Yes” or “No” but please do at least give me a “Yes” or a “No”.
It’s important for the future of TradeStops.
To the growth, and protection, of your wealth,
Richard M. Smith, PhD
Founder & CEO, TradeStops.com
Introducing Smart Trailing Stops 2.0!
Smart Trailing Stops are about to get smarter.
As you know, I designed Smart Trailing Stops to tell us exactly how much wiggle room we need to give any stock in order to not be stopped out of the stock by normal expected volatility.
Giant blue chip stocks like WalMart or Johnson & Johnson don’t need nearly as much wiggle room as more volatile stocks like Netflix and Tesla.
By tuning our stop losses with volatility, we’re able to take less risk and lock in more profits on WMT and JNJ, and we’re able to give more room to stocks like NFLX and TSLA so we don’t get prematurely stopped out by the extra volatility in these noisier stocks.
If your stops are too tight on noisy stocks, getting stopped out is almost inevitable. If your stops are too wide on conservative stocks, then you are taking unnecessary risks.
That’s the basic idea.
By combining these volatility–based stop loss points with position sizing, we’re able to adjust our position sizes so that we take an equal amount of risk in each of our investments instead of putting an equal amount of capital in each of our investments. (I recently wrote about this strategy here in Make Big gains by Taking Less Risk.)
I’m proud of these new tools and I’m very happy that I can deliver them to my subscribers. They are easy to understand and easy to use and I believe that they can and will dramatically improve the performance of investors who use them.
But I’ve continued my research behind the scenes and I’m now going to share with you my latest breakthrough (which I plan to start delivering to my subscribers in the next few weeks).
Consider the following chart of Tesla from the beginning of 2014:
Clearly, Tesla made a significant high in September of 2014 at around $285. Right?
Let’s say that we were looking to buy Tesla in early November of 2014. At that time, Tesla was trading around $240. It was already down about $45 or 16% from its September high.
In early November 2014, my algorithms told us that the normal expected volatility on Tesla was 41.3%.
If we knew that Tesla could move as much as 41.3% peak to trough in its normal course of business, wouldn’t it make sense to place our stop loss 41.3% below the September high, even if we’re buying into the stock a couple months later in November?
The traditional way of using trailing stops is to start tracking them from the point in time that you enter a position. So if we were going to set a stop loss 41.3% below the November entry price of $240 we would set the initial stop at $140.88.
On the other hand, if we set our stop 41.3% below the September high of $285 then our initial stop loss point will be at $167.30.
Let me show you how this looks on the chart:
By trailing our stop from the September high at $285 instead of from our November entry at $240 we would have further reduced our risk in Tesla by raising the initial stop loss point to about $167 instead of about $141.
Wouldn’t it be great if we could confidently identify the recent high in any stock and trail our smart stop from there instead of just trailing it from our random entry point?
Yes it would… and this is exactly what my next generation Smart Trailing Stop algorithm does.
I’m excited to start sharing these new advances with subscribers by April of this year.
Next week I’m going to share with you some new language that I’m using to better describe my latest work.
To the growth, and protection, of your wealth,
Make Big Gains by Taking Less Risk
What separates the winners from the losers when it comes to investing?
I wanted to know.
Fortunately I wasn’t afraid to ask…
Early on in my investing, I had been up and I had been down… but I have to admit, it was more down than up.
What was I doing wrong?
I love to learn, and I’m not afraid to go right up to the “authorities” and ask them direct questions. So that’s what I did…
“What’s the difference between the winners and the losers in the financial markets?” I asked an investing legend at a conference once
“The winners don’t need the money,” he said.
My immediate thought was, “Ah, yes, of course. The little guy is never going to win at this game. The fat cats have the game rigged. The rich just keep getting richer and the rest of us just get the squeeze.”
That’s what I thought at first. But that wasn’t right…
I gradually discovered a deeper meaning in this guru’s pearl of wisdom.
Was there a way that I could put myself in a position of not needing the money, even though I wasn’t rich?
The answer I found surprised me…
I found a way to know the riskiness of a stock before I buy it.
This is an incredibly powerful idea. Let me show you how this idea works…
The current “Smart Trailing Stop” on JNJ, for example, is about 10%.
Let’s say that I decide to buy JNJ and that I’m willing to risk $1,000 on this investment opportunity.
When I say “willing to risk”, I mean that I’m willing to lose up to $1,000 before getting stopped out and moving on to other opportunities. (Remember, capital is finite… opportunity is infinite.)
So if I only need to use a 10% stop loss on JNJ and I’m willing to risk $1,000, how much money can I invest in JNJ?
The answer is $10,000.
If JNJ falls 10% then my original $10,000 investment will be worth $9,000 and I will have lost $1,000.
TSLA, on the other hand, has a Smart Trailing Stop of about 40%. That means that the price of TSLA can swing as much of 40% in its normal course of business.
If I am willing to risk $1,000 in TSLA, how much can I invest?
The answer is $2,500.
If TSLA falls 40% then my original $2,500 investment will be worth $1,500 and I will have lost $1,000.
I can invest $10,000 in JNJ and only $2,500 in TSLA and still be risking $1,000 in each investment.
That’s a different way of looking at it… and it almost makes JNJ the more exciting investment!
Let me show you what a game–changer this simple strategy can be.
I mentioned yesterday that I had always been a big fan of Dr. Steve Sjuggerud’s work.
I was not surprised when some back–testing that I helped with found out that Steve had delivered his readers annualized gains of 16.8% per year over the 10 year period from 2004 to 2013.
That’s very impressive performance.
I love to put my systems to the test to see if it is possible to improve upon outstanding performance.
Let me show you what I found.
The following chart shows how much net profit could have been made by a True Wealth reader if:
- An equal amount of money ($1,000) is invested in each recommendation (gray line)
- An equal amount of risk ($250) is taken on each position (black line)
Using the equally weighted strategy produced a net profit of $21,588.
Using the dynamic position sizing strategy produced a net profit of $32,782.
That’s an astonishing improvement of 52% on what was already market crushing performance.
Combining Smart Trailing Stops and position sizing is a very powerful method for making sure that you are “positioned for success” in the markets.
What do I mean by “positioned for success”? I mean that you are investing in your personal risk comfort zone…
Only you know what level of risk is going to allow you to sleep comfortably at night and not feel like you need to check the markets all the time to see what’s happening with your investments.
Most people think that you’ve got to take big risks to make big money in the markets. I have found that this simply isn’t true.
The secret to making huge gains in the markets is to invest in a way that you “don’t need the money” – that you can’t be shaken out of your positions before your profits have had time to fully ripen.
Smart Trailing Stops and position sizing are powerful tools for making sure that you’re one of the market’s winners. I hope I helped show you one of the reasons why today, and I hope that you’ll use Smart Trailing Stops to grow and protect your wealth…
To the growth of your wealth,
Richard M. Smith, PhD
Founder & CEO, TradeStops.com
The Most Important Chart in Investing
Today I’d like to share with you what I believe to be the most important chart in investing.
Queue the drums! Raise the bugles!
The Average Investor’s Response to Gain & Loss
Kind of simple, huh?
This chart captures what I believe to be one of the most important challenges that all investors must overcome in order to really succeed in the markets – the tendency to prefer our losers over our winners.
What do I mean by “prefer”?
This is a chart that shows how we respond to gains and losses in the markets. The vertical axis here, behavioral economists call this by the academic descriptions of “value” or “utility”.
I like to think of it as the emotional impact of our gains and our losses.
As our gains get bigger, the emotional impact of those gains tapers off. If we get a 100 percent gain, that’s fantastic. If we get a 200 percent gain, you know, it’s great but, emotionally, it’s not twice as great as a 100 percent gain.
On the other hand, when it comes to losers, as losses increase (to the left) the impact of those losses doesn’t taper off in the same way that the impact of the gains tapers off.
As losses get bigger, the emotional impact or our attachment to those losses, intensifies.
If we get a 25 percent loss, that hurts. But if we have a 50 percent loss it hurts a whole lot more. You have a 75 percent loss, it’s really a killer.
As losses grow they become very consuming. We get very attached to those losing positions. We can’t let go of them.
That’s why I say that many investors prefer their losers… because they hold on to them.
Most people get stuck in their losers, very emotionally attached to those positions. It’s hard to let them go.
Maybe we’ll even double down on those losses and try to get back to “break even” quicker. Right?
I can’t tell you how many times I’ve heard people say, “I’ll get out when it gets back to break even.”
If you ever hear yourself say, “I’ll get out when it gets back to break even,” it’s time to get out now. It’s a sign that, regardless of what happens with the stock, your mind isn’t in the right place about it.
Benjamin Graham, the father of value investing and mentor to Warren Buffett, once said, “The investor’s chief problem and even his worst enemy is likely to be himself.”
That certainly rings true for me.
Many investors, after getting burned a few times, realize that taking big losses is a really bad idea.
Not only is it tough on your portfolio but it’s tough on you psychologically. It beats you up and discourages you from taking advantage of future opportunities.
That’s why many investors pretty quickly agree with the idea that you’ve got to cut your losers.
If we refer back to our original chart, we might say that this more “experienced” type of investor can get his or her behavior chart to look like this:
Intermediate Investor’s Response to Gain & Loss
This “intermediate” level of investor has stopped the bleeding by learning to limit losses.
Few investors, however, every truly master the art of staying in their winners.
There’s a famous saying, I think that it was by John Maynard Keynes – “Markets can remain irrational longer than you can remain solvent.”
That’s true! Financial markets regularly go places that no one expects them to go.
The key to life–changing gains in the stock market is to make that market madness work for you instead of against you – turning our original chart on its head so that it looks like this:
Advanced Investor’s Response to Gain & Loss
Come to think of it, I guess that I have to take back what I said earlier… THIS is the most important chart in investing.
To the growth of your wealth,
Richard M. Smith, PhD
Founder & CEO, TradeStops.com