Let’s dive into the reader mail for another great question. This one is about struggles with trailing stops and a question about cash reserves.
First of all – the investment information you share through your web site really resonates with me! But I struggle with two topics.
1.) I utilize trailing stop loses alerts to minimize my loses and / or lock in gains. This strategies works well but an investor needs to be disciplined and follow through on selling a stock if the alert is triggered. What happens if the market quickly switched from being bullish to being bearish. I could receive alerts for all of my investments. Theoretically I should sell, sell, sell. But this is different from the advice to stay in the roll a coaster and ride out the dip in the market.
2.) How much cash should be held in a portfolio in order to purchase undervalue stock(s). Does an investor always have a percentage of cash on hand in order to purchase stock or dollar cost average in a stock they already own, if the stock price dips? If the cash is used to purchased a stock, does the investor then need to sell investment(s) in order to replenish the cash reservoirs?
Your thoughts on the topics would be great appreciated!
Thanks for the kind words. It’s true you have to find a balance with the trailing stop. Here’s what I think.
1) I introduced the two approaches I take about when to sell a stock in my Value Trap Indicator ebook. Here’s an excerpt from the in-depth explanation.
“There’s two separate approaches that I condone to solve this selling dilemma. The first is effectively used in my newsletter portfolio, The Sather Research eLetter, and recommended to my newsletter subscribers. The tactic is called a trailing stop, and it is so effective both because of its simplicity and the fact that it takes emotions out of the trade. A trailing stop creates a floor for a stock, and if the stock hits that floor then it becomes an automatic sell (see trailing stop explanation here).
The secondary approach for when to sell is also similar to the trailing stop because it creates strict rules that can’t be broken yet gives a stock more chances to recover. In this instance, I advocate not selling a stock no matter how far it falls, as long as you had conviction with your original analysis and you have an established point of when enough is enough.
This kind of an approach seems to be very popular with value investors, who by their nature tend to be extremely confident and more risk averse because of it. The importance here is that the rules for selling must be set in stone. In my case, I set the following three rules for automatic selling.
Examples of Actual Warning Signs
1. Complete cut of the dividend
2. Substantial increase in the debt to equity ratio
3. A year of negative earnings”
Basically, I use the two different strategies in my different portfolios. It has to match the mindset behind the stock pick. So I have a trailing stop portfolio and a own for “forever” portfolio. With a trailing stop you are still riding the dips as long as you are reinvesting after selling. I reinvest the next month after I sell in the trailing stop portfolio. Also, that portfolio is in a Roth IRA, so I’m not penalized tax wise for selling early.
2) That’s personal preference. For myself, I don’t hold much of a cash reserve except for my emergency fund. I’m always invested. But I do know many value investors keep a cash reserve and try to time the markets. You can be successful either way. I prefer to receive dividends and invest my cash ASAP, because I know I will be consistently investing.
Even if this strategy doesn’t work out short term, i.e. a new market crash and opportunity to buy stocks, I still have peace of mind because I’d prefer to stay invested… over the long term this should benefit me more because I’ll ultimately be slow, steady, and consistent rather than trying to predict the future.
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**Finding Balance with a Trailing Stop vs. Buy and Hold**