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Trailing Stop Strategies

The Smart Profits Report: Issue #437
Wednesday, July 11, 2007

Trailing Stop Strategies: How To Avoid A $190 Million Portfolio Mistake
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

If you lost $190 million trading tech stocks when the dot-com bubble unceremoniously popped back in 2000, would you want your money back?

Of course you would. Who wouldn’t? But while many folks might grab the whisky bottle, chalk up the loss to some poor decision-making, and vow to never make the same mistakes again, one guy has actually asked for his money back because he didn’t use any trailing stop strategies.

Swallowing A $190 Million Loss

Fred DeLuca, billionaire co-founder of the Subway fast-food chain, lost $190 million when the flimsy dot-com house came tumbling down at the turn of the century.

Not much for a guy who Forbes says is worth $1.5 billion, but DeLuca alleged that his UBS brokerage mismanaged his trust money, causing him to lose the money on risky tech stock investments. And he wanted it back. UBS said DeLuca authorized the investments and the losses came because of his aggressive growth strategy at the time.

And this morning’s Wall Street Journal reports that a National Association of Securities Dealers arbitration panel has rejected DeLuca’s claim.

Tough luck for the sandwich man. But for us, a couple of things are clear:

  • First, his aggressive strategy overshadowed basic logic regarding the sector’s risky long-term prospects. Many companies had shaky business models and no profits - and Wall Street fueled the boom with ceaseless hype.
  • Second, the hunt for profits included no exit strategy like using trailing stops, for his portfolio and DeLuca was trying to blame someone else for his losses.

What we can learn from a $190 million mistake? There are a couple of key things that any investor can do to protect and grow a portfolio.

  • Keep your losses small by using an exit strategy such as a trailing stop.
  • Take responsibility for all your investing decisions.

But while these concepts sound simple, they’re tough to consistently execute. Just ask Fred DeLuca. However there are ways to make sure these actions show up in your investing.

Stop That Loss! Trailing Stop Strategies Never Fail

If it seems like we mention the importance of employing trailing stops or stop-losses on all your positions a lot, the reason is simple: This strategy works.

And don’t be fooled by the current market climate. Even as stocks are making more new highs, investor euphoria and complacency are at very high levels. Hardly surprising, considering that the market is in the middle of its longest sustained run (a bull move without any 10% pullbacks) since the 1920s!

So if you don’t think trailing stops are worth it right now, this is exactly the same sentiment that existed when DeLuca lost his $190 million. He (and many others) thought the market could only go in one direction - up. And as a result, he was very aggressive with his capital. But he paid a huge price when the market proved, as it inevitably does, that it goes down as well as up.

The bottom line: Don’t let market euphoria cloud your thinking. Make sure you have exit and trailing stop strategies in place for all your positions.

An Overlooked Characteristic Of Successful Investors: Taking Responsibility

Fred DeLuca is an extremely successful businessman. I’m sure that in the business world, he knows how to take responsibility for his actions, or he would not have achieved the success that he has. But in the investment world, he tried to blame his broker for his $190 million loss. Not a good idea.

My good friend and author, Dr. Van K. Tharp, constantly reminds investors of the key concept of taking full responsibility for their own investing results. And the reasoning is very straightforward. If you blame someone or something else for your trading results, you lose sight of what went wrong in the first place and doom yourself to making the same mistakes again.

The bottom line: Nobody cares more about your money than you! If you lose on an investment, figure out why and take full responsibility for the results, even if you use newsletters or a financial advisor. And don’t forget to implement a few trailing stops strategies for all of your portfolio positions.

Great trading,

D. R. Barton, Jr.

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Today’s Smart Profits Action Center

  • A Trailing Stop is a stop-loss set above or below depending on what the current price is as the price fluctuates. For a long position, a trailing stop would be set below the current price and would rise as the price advances. As long as the price remains above the trailing stop, the position is held; should the price fall and reach the trailing stop, then the stop-loss would be triggered and the position closed. For more helpful tips like this, check out the Smart Profits Glossary.
  • Think $190 million is a big loss? Spare a thought for investors of bonds backed by U.S. sub-prime mortgages. In a report released on Monday, Credit Suisse Group says total losses could hit $52 billion, due to the rapidly increasing number of foreclosures and delinquencies. In fact, first-quarter figures show that borrowers defaulted on sub-prime mortgages at the fastest rate since 2002.

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