CAPM Portfolio: Those %^!*$& Trailing Stop Losses

It’s time for some exits, because our stop losses have been hit. Of course, both the stops we did execute aren’t losses in the sense that we lost money in the trade, but it’s a trailing stop. Let us explain.

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A trailing stop is like this: A stock keeps going up. From it’s highest point, it should not retrace more than 10%. So the stop loss is 10% that “hangs” off the highest point after you have bought.

For clarity, we’ll use the closing prices, not intraday highs. This is to reduce activity, and reduce intraday volatility.

In general, for India, we would use a 15% to 20% trailing stop. This is because Indian stocks are very volatile and 10% may not be enough. The idea of a strategy is that the regular “wiggles and jiggles” should not throw you off the horse. For small caps and midcaps 10% is regular.

Recently, however, on the back of higher volatility, we’d decided to tighten up the portfolio and cut stop losses to 10%. Let’s give or take a little, based on support levels. One of the key things that this does, is to throw you off the horse faster, and possible sooner than you would like - but in volatile times, it’s better to be safe than sorry.

A number of our stocks have come close to, or hit their trailing stops. This is surprising as the market hits new all time highs. But remember that most of the stocks we bought were small caps. In these stocks, investor interest is not institutional - mutual funds or FIIs don’t really jump around buying these stocks, for the most part. Most of the recent move has been in a few select large caps. This has resulted in some profit booking in small caps, which have therefore retraced from recent highs.

Here’s a quick look at our stop hitters:

Alembic Pharma: Retraces 10%

We bought this stock at Rs. 223 in Jan 2014. It went all the way to Rs. 306, and has since retracted down to 265 with a -3% move today.

This also takes out a previous low, as you can see above.

We had earlier seen a big retracement. But at that time, our stops were wider, so we just let it be. This time, though, because of our election surprise tightening and the lower-low trigger, we would choose to let the stock go.

Our exit point was at 327 at the end of the day. (While we note that as our exit, we’ll reprice it if the stock is much lower tomorrow)

Profit on this trade: 19.7% in five months.

Kaveri Seeds: Goodbye Dear Agricultural Bet

In a 5% down day, Kaveri Seeds takes out the trailing stop and also the previous low.

We’ll keep Rs. 570 as the exit point.

You’ll note that we probably did get an early warning when the 20 DMA was breached (purple line) earlier in the month. The stock has respected the 20 DMA since December 2013. When it it break below, it broke down. But the MA break is a weak indicator in general, and it needs some other confirmation - last low breach, Lower bollinger band break or a momentum breakdown such as RSI.

It might also be that the El Nino this year will disrupt the monsoon, and rumours took it down. The point is sell first and then question why.

*Profit: *15.2% in four months

Close But Not Yet Out: KPIT, Strides

KPIT Technologies seems to have hit the 10% down point today closing at 159.7, which is 11% lower than our purchase price (which was near the highs)

We’ve given this stock way too much leeway. It’s the worst loser in the portfolio, and the wide outer stop hasn’t helped at all. We brought the stop in to the last low of Rs. 160. The stock closed just below. In tomorrow’s action, if it doesn’t recover upwards, it will be sold.

Strides Arcolab closed at 484, which is lower than the 10% retracement value of Rs. 490. However, we would like to give this stock a little more leeway.

The stock has closed just below the 20 DMA. So if it doesn’t go back up tomorrow we would sell half the holding. This stock has a large potential dividend coming up, so let’s leave the other half for a breach of the previous low of Rs. 450.

The rest of the stocks aren’t off too badly.

We Do Talk About Exits

In all too many cases, you hear of people telling you to buy. But they don’t tell you when to sell. At Capital Mind Premium, we believe it’s as important to tell you about exits. Entries are easy. It’s the selling that tests the mettle of the investor.

There is no shame in admitting when things aren’t going right. While we call these exits “Stop Losses” you’ll notice that in most cases we’re actually pretty profitable. That’s the power of a trailing stop - as the market goes higher, it converts your losses into profits! We hope this is a learning exercise as well.

The biggest problem with trails is that the stock might reverse just as you exit. This has happened to us many times. The enemy of the disciplined trader is two feelings - euphoria and regret. These cause too many stomachs to churn, while markets go about doing things differently. But having the discipline to stick with the broad rules you set will make for better long term investing, even if it means short term exits. The points that Ed Seykota, a famous trader, makes is:

a) Cut your losses

b) Let your profits run

c) Follow the rules

d) Know when to break the rules

We’ve broken the rules in two stocks (KPIT and Strides). That, we hope, is for the best!

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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