One of the unique things that we do in TradeStops which few, if any, other services do, is to adjust trailing stops for dividends and other corporate actions.

In fact, I had a colleague from TD AmeriTrade once tell me that he used TradeStops himself for just this very reason. “No one else adjusts alerts for corporate actions like TradeStops does,” he told me.

In order to understand why we go to the trouble to offer this unique benefit to our subscribers, let’s take a look at a high yielding stock like Annaly Capital Management (NYSE: NLY).

NLY pays a 30 cent dividend every quarter. That’s $1.20 in dividends per year. With the stock trading around $10.00 currently, that’s an annual yield of about 12%.

Let’s say, for example, that you were an investor in NLY on December 26, 2013. On that day, NLY closed at $10.12 per share. Anyone that owned shares as of the next day (December 27, 2013) got paid a dividend of $0.30 per share. December 27, 2013 was the “ex-dividend” date.

On December 27, 2013 NLY closed at $9.83 per share after having closed the prior day at $10.12. What happened? Had NLY dropped $0.29 per share in value overnight? Had NLY shareholders lost money?

No.

NLY shareholders were actually up $0.01 per share by the close on December 27, 2013. They still held their shares, now worth $9.83 and they had guaranteed payments coming of $0.30 per share. Adding those together gives a total of $10.13 per share, which was up $0.01 per share from the previous close of $10.12.

You’ve probably heard the phrases “adjusted prices” and “unadjusted prices” in reference to stock price histories.

“Unadjusted prices” are price quotes exactly as they were quoted on any given day in market history. “Adjusted” historical prices, on the other hand, reflect the impact of corporate actions like dividends and splits on past historical price quotes.

Remember that NLY had closed at $10.12 on December 26, 2013, the day before its ex-dividend date and then closed at $9.83 the next day? If you leave the “past price” of $10.12 “unadjusted” then it looks like NLY lost money from December 26 to December 27.

Here’s how that would look on a short chart of daily closing unadjusted prices from December 23, 2013 to December 31, 2013.

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As we saw above, however, shareholders in NLY didn’t actually lose money from December 26 to December 27. They were actually up a penny!

In order to have this reality properly reflected in historical prices, we need to “adjust” the historical prices by subtracting the $0.30 dividend from past historical prices. In the following chart I’ve adjusted the historical prices prior to December 27, 2013 to reflect the dividend payment (and I left the unadjusted price history as the dashed line):

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See the difference? Now the price history accurately reflects the fact that shareholders gained a penny in value from the close of December 26, 2013 to the close of December 27, 2013 (instead of having lost 29 cents).

In a high-yielding stock like NLY, these quarterly dividend payments can have quite an impact on the price history of the stock. The following chart shows the unadjusted price history (dashed line) vs. the adjusted price history (solid line) from December 2013 to today:

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As the amount of accumulated dividend payments increase over time, the gap between the unadjusted and adjusted price histories gets wider and wider. Remember that as of December 27, 2013 the “adjusted” close for NLY on December 26, 2013 was $9.82? As of today, that adjusted close is $7.83! As more and more dividends have been paid, the closing price of December 26, 2013 has been adjusted down again and again.

(One small but important aside … There is a special algorithm for adjusting historical prices for dividends. If you’re interested, you can read about it on Yahoo Finance here. TradeStops uses the same algorithm as Yahoo. The reason for using this approach is so that past historical prices don’t ever become negative as more and more dividends are subtracted.)

Now that we understand unadjusted versus adjusted price histories, we can finally take a look at why we default to using adjusted price histories for calculating trailing stop loss levels in TradeStops.

Just looking at the chart above it’s clear to see that the unadjusted and adjusted price histories have very different high closing prices. The high close of the unadjusted price history occurred on August 21, 2014 at $11.92. The high close of the adjusted price history wasn’t even on the same day as the unadjusted high close. The adjusted high close occurred on December 4, 2014 at $10.06.

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The value of the high closing price is absolutely critical to where your trailing stop loss is. If you’re using a 25% trailing stop, for example, on NLY and you bought NLY in December 2013, you will have a very different stop loss point if you use unadjusted historical prices than you will if you use adjusted historical prices.

If your stop loss is 25% below the unadjusted high of $11.92 then your stop is at $8.94 … and you would have actually been stopped out in early 2016!

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On the other hand, if you’re using adjusted prices for calculating your stop loss points, then your 25% trailing stop is calculated from the adjusted high of $10.06. Your stop is at $7.55 and you’re not yet stopped out of NLY:

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Why the big difference?

If you’re not adjusting your stop loss points for dividends then the dividends are effectively acting like losses. Since December 2013 NLY had paid $2.70 in dividends and each of the 9 dividends at $0.30 a piece came out of the price of NLY on the ex-dividend date.

That’s a very strong headwind for a trailing stop to fight … and that’s why we go to the trouble of offering adjusted price histories in TradeStops and to adjusting all trailing stop loss points for dividends automatically on the ex-dividend dates.

To great investing … made easy,
Richard_Signature
Richard M. Smith, PhD
CEO, TradeSmith
Founder, TradeStops.com