It’s said that a picture is worth a thousand words. I agree … and that’s why I’m going to great lengths to paint pictures and tell the stories of real world investors and their experiences … so that we can all become better investors.
Last week I wrote to you about the unclaimed profits that investors are regularly leaving on the table when it comes to their investments. I shared specific examples from one brave soul, Mark, who was willing to take a hard look at his past performance in search of new and improved opportunities.
Let’s pick up where we left off last week and continue examining real investments by real investors and how intelligent position sizing and stop loss strategies can improve performance.
Esperion Therapeutics (ESPR) was a hot-topic biotechnology company in the summer of 2015. It had a candidate cardiovascular / cholesterol drug, ETC-1002, in testing with the FDA. The stock peaked at nearly $115 in June 2015. Then, uncertainty surrounding the FDA review brought the stock down to $80 by late June – a decline of over 30% – and created an “opportunity”.
Another of the investors in our recent study purchased $22,312 of ESPR on this “dip.” Here’s what the chart of ESPR looked like at that time:
ESPR immediately rocketed back to nearly $100 over the course of just two weeks for a quick paper gain of $5,500.
Then, as is often the case, disaster struck. ESPR dropped 40% in under two weeks as the sought after FDA approval was unexpectedly delayed:
I give you all of this detail because I know, if you’re like me, you can feel this investor’s pain … and dismay. What the heck just happened? I was doing so well. What do I do now? Is it going to bounce back?
This is a predicament that investors find themselves in far too often … and more often than not, become paralyzed with uncertainty. That’s certainly what happened in this case. The investor finally threw in the towel a year later when ESPR eventually bottomed out near $10 per share for a total loss of 86% or $19,208.
Let’s take a look now at how volatility based position sizing and trailing stops could have helped with this particular investment.
This particular investor had a large portfolio of several million dollars. At the time of the original investment, ESPR had a VQ of 48.3%. That’s a very volatile stock but given the large size of the portfolio, this investor could have invested even more money in ESPR than the $22,312 he originally invested.
Given the portfolio size and the VQ of ESPR, the TradeStops position size calculator calculated an initial investment size of $43,341 – nearly double what he originally invested.
I know what you’re thinking at the moment. “Wait a minute? TradeStops suggested a larger position in this loser?”
Yes, but … it’s position sizing AND stop losses together that have the biggest impact. Let’s see how that played out with this particular investment in ESPR.
The following chart shows where the VQ based trailing stop loss system would have thrown in the towel on ESPR vs. where the investor finally threw in the towel himself.
That was a tough stop loss to execute on … especially if you would have had to watch the stock immediately go back up $15 per share right after you “followed your discipline.”
It turned out to be the right thing to do, however. Here’s a table of how all the numbers lined up for this particular trade:
Both outcomes produced a loss but the “sized and stopped” strategy produced a smaller overall loss, even though it started out with a larger initial position.
Losses in investing are unavoidable … but when you combine smart position sizing and smart trailing stops, your outcomes are going to be better more often than not.