Ask Colin

In placing your stops, what is a trough?

The detailed question was:

A quick question on your second additional sell stop rule as it relates to your BXB update on 30 Jul. I don’t hold BXB but I have a couple of stocks that have exhibited the same pattern.

 

From a recent high of 11.95 on w/e 10 Apr., BXB:

fell more than 10% to 10.66 on w/e 1 May,

went back up to 11.59 on w/e 29 May,

down more than 11% to 10.26 on w/e 3 Jul, and

went up to 11.43 on w/e 24 Jul.

 

This looks like a textbook (your textbook) sell signal (w/e 19 Jun).

 

I understand that it can be hard to decide “what is a trough?”, but I refer to your current soft stop which you placed under a trough that is less than 9% below its preceding high (14 Oct 14). If 9% was a trough then, surely its a trough now. I raise this because, as I say, I have seen the behaviour in several of my stocks and a couple more of yours (RHC arguably and BYL definitely), and they don’t feel like “sells” to me. Rather, I think the movements are just reflective of recent overall market movements, but because I agree with your insistence on discipline, it would be nice to firm-up the rule and rely less on judgement in such cases. On the other hand, I could be simply misunderstanding the rule.

 

There are many ways to define a sell-stop rule in our investment plan. The way I do it is something that I have tested over a great number of stocks that I have invested  in or paper-traded over 50 years as I have developed my methods. There are several very important ideas in that statement:

  1. It is only by carrying out that research and living that experience that an investment plan can be developed. It cannot be done theoretically in a vacuum. Paper trading a chart is one way to gain experience faster, but of course, real money is not involved, so it is of lesser value than real experience which involves our emotional involvement in real investments. There is no way to short-cut this. Each of us has to do this work for ourselves. Trying to just copy someone else’s investment plan (or worse, just a part pf it in isolation) will not work – under pressure in the market (as perhaps you might have been with the stocks you say had charts that unfolded like Brambles) will see you question it at a time when you must have no doubts in your mind after close analysis of the chart in relation to your investment plan. Why you will be questioning it is because you have not developed the deep understanding that leads to faith in the method that is your investment plan.

  2. Next, there are many ways to set stops. The way you do it will depend on the other elements in your investment plan because there are very few parts of an investment plan that are truly independent of the others. In my book Building Wealth in the Stock Market you have my plan. The way I set stops in my plan comes back to the edge I am exploiting when I buy good stocks at low prices relative to value. I do that with a chart-based timing element based on my two models. In both cases, I am looking to buy upward breakouts of accumulation or consolidation patterns. That is the timing element, but then I have the filter that price must be low relative to value and a multi-faceted evaluation of the business I am buying part ownership of. If the stock passes those tests, my model gives the expectation that an uptrend will unfold. I define an uptrend and from that my stops are where I define that uptrend to have failed to unfold or to have continued to unfold. That is my method and reflects who I am and my life journey to this  point. No other investor with have had my journey, so they have to develop a plan that fits who they are and the path they have taken to this point in their life.  

  3. From the deep and ongoing reflection, research, testing and experience comes a key understanding: no two charts ever unfold in the same way. All stocks have their own character derived from the market  participants who own the company as investors or who trade in its shares for various reasons (traders, HFTs, index funds and so on). When  you look at the theory diagrams in Building Wealth in the Stock Market, do not for one moment expect stock charts to look like that. Those are simply diagrams that explain the way I set my stops based on my definition of a trend. Every now and again you get a chart that for a time seems to unfold just like the diagrams – currently I think you could say that Collins Foods is a “textbook-perfect” example and it has clearly been easy to interpret that chart and move my stops as per my investment plan. Most stocks do not unfold so nicely. That is where experience comes in. It requires a learned ability to read what is happening on the chart and to make a judgement. Greater experience and depth of research should provide an edge in the quality of the judgement made.

This leads to the point: how can I pass on some of my research and experience? I do this by first, publishing my investment plan and second, publishing my investment journals and other materials in close to real time so that members my follow my thinking. Feedback I get is positive in this respect, but I do stress that it is essentially limited. Each investor is different and there is no way that I could ever take their myriad investment journeys for them.

You have asked about some specific stocks. I am constrained by the law in that to answer the sort of question you are asking is in my understanding not just general advice (a view about a stock), but specific advice to you, a specific investor about specific stocks, whether you own them or not. Saying you own stock like the one you ask about is a huge danger signal in defining specific advice. I find the law very frustrating in this, but I am bound by it. So, I cannot legally comment on the charts you mention. However, I am listening to your need and will try in future to expand my discussion of stop placements in investment journals on the members website. I am able to do that there because it is never specific advice, but a teaching tool in the form of an explanation of my thinking in the stated context of my investment plan and behind a disclaimer wall.

Nevertheless, I hope the general discussion above is of use to you in pointing the way along the path that is jour investment journey.

I know that nobody is happy with this – and that includes me – but while the law is as it is, there is no other option that I can see open.

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