Nearly all of the remarkable advances that are part of Tradestops today grew from one simple underlying question – how to improve upon the 25% trailing stop order.
We looked last week at how Bill Gates got out of COG with an 11% gain whereas the Tradestops volatility based stop-loss strategy would have produced a 230% gain.
At the time of Gates’ investment in COG, the VQ on COG was 46%. You’d think that if a 46% trailing stop produced gains of 230% that a 25% trailing stop would have at least produced some respectable gains as well.
You’d be wrong. Using a 25% trailing stop on COG would have produced a loss of 9%.
COG is a great example of the fact that if you use too tight of a stop loss on a more volatile stock you’re almost guaranteed to lose money.
Prem Watsa had a similar situation with his investment in Methanex Corp.(MEOH).
In 2009, when Watsa first bought MEOH, the VQ for MEOH was 41%. A 25% trailing stop loss on MEOH would have actually produced gains of about 68%, those gains pale in comparison to the 311% gains that a 41% volatility-based trailing stop strategy would have produced.
We’ve seen what happens with stocks that have greater volatility than 25%. But what about a stock that has lower volatility?
At the time that Warren Buffett purchased CVS Health Corp. (CVS) in late 2011, the stock had a VQ of about 24%. As the stock moved higher in price, the VQ of CVS dropped to under 13%. This trailing stop was triggered with a gain of 160%.
But the 25% trailing stop didn’t trigger for another year and the gain was cut dramatically. This is a great example of taking too much risk in a stock.
Taking the right amount of risk on every stock in your portfolio is a powerful way to maximize the gains on all of your investments. It’s as powerful today as it was when I first developed the approach 3 years ago.
It’s good to see that it’s not just you and me that stand to benefit from smart risk management. It could help Gates, Watsa and Buffett as well,