An Ounce of Prevention
With a big correction taking place across Chinese and Hong Kong markets, a reader wrote in to tell us that he was approaching his trailing stop loss on Hong Kong’s Hang Seng index tracker ETF.
But, he pointed out, the market was now trading at a very attractive level in terms of valuation.
The question: shouldn’t he just hang on with the trade?
Anyone who uses a trailing-stop discipline will encounter this situation at one point or another…
… and it’s a good example of why I refer to trailing stop losses as a ‘discipline’.
So let’s break it down a little here…
The first thing to remember here is that our number one priority here isn’t making money.
That may sound strange coming from an investment newsletter, but it’s true.
Our priority is not making losses.
Given that ANY investment involves risk, then our priority becomes minimising losses.
It was Benjamin Franklin who said “an ounce of prevention is worth a pound of cure”.
The trailing stop loss is our ‘ounce of prevention’ against the kind of 50% or more loss that drags down your portfolio performance.
That’s the kind of loss which then needs a 100% gain (i.e. a pound of cure) to get us back to even.
The reader rightly pointed out that at less than 12 times current year earnings, Hong Kong’s Hang Seng index is pretty cheap.
But that’s simply not relevant right now. Plus it was cheap when we recommended it in the first place!
What IS relevant is that we hit our trailing stop.
By acting on our stop it means is that we immediately eliminate any further potential downside.
When you hit a stop, the rule is act first, analyse later.
You see, just because we exit a trade, it doesn’t mean we can’t re-enter it again in the future.
Withdrawing from the position allows us to step back, reassess the market and the opportunity, revisit our thesis and go from there.
The problem with ‘hanging on’ is that we are allowing a small loss to potentially become a big one.
I would much rather forgo some upside to protect against a lot of downside.
Give me the ounce of prevention any day…
Speaking of prevention… I just had CNN’s Asia Pacific Editor, the outstanding Andrew Stevens in my office earlier today. So of course, we talked about China as a market that’s dominating the news right now.
Last week I wrote (“Is It Time to Buy Back into China?“:
“I am not convinced that the turmoil has died down yet. Policy measures here are helping, but they will not drive this market north just yet.
We will bide our time before re-entering the fray.
They say “don’t fight the Fed.” Well, we’re not fighting the PBOC (and all the others)… we’re just stepping aside.”
Well, yesterday the China market had its biggest single day drop in 8 years, falling by more than 8.5%.
And Hong Kong’s Hang Seng Index fell by more than 3%.
Investors who tightened their trailing stops on our primary China recommendation (and carried them out!) have avoided this stomach churning volatility.
But this kind of market bloodletting will provide us with fantastic opportunities to buy great companies at bargain prices… but that’s for later.
We want to have some cash for when this market starts to bottom out.
In the meantime, please keep to your trailing stops, and continue to bide your time on a broad re-entry into the China market… this ain’t over yet.
There are still opportunities in China. Subscribers will read all about our latest pick in The Churchouse Letter published later this week.
P.S. You might ask, “can you change your stop loss level after you’ve bought in?”
Yes. You can…
We did that on our China stock recommendation, BUT we tightened it. And we certainly didn’t change it after we’d gone through it!
For us, the China situation did change… from a rally into a bubble. We changed with it…
The China market continues to get crushed… but that’s somebody else’s problem right now.