June 22nd, 2016                        Also available in PDF

The Revisited Stop Loss III           (Part 3 of 3),    (for Part I, Part II)

 

Another Stock

Should the picture change that much if I change the stock under the microscope?

I picked FDX from the same 10-stock list I often use in testing trading procedures. If a stock can pass my preliminary tests, then I can go further with the exploratory analysis.

It is when you change the stock under study that you can better view common elements. And from there maybe extract further trading rules designed to help at the portfolio level and not just apply to a single stock.

This trailing stop strategy does not care what the stock is in the sense that it is concerned only with price movements. And all stocks, whatever their respective paths, with have variable price fluctuations, each having their own signature. Still, for any stock, the number of tailing stops are numbered. They get executed or not but the stops will be the same for everyone at a particular setting. If a stock has dropped 10% from its recent high, it can be seen and acted upon by all participants.

Notwithstanding, here are the results for FDX on the $10k scenario as in chart #1:

#7  FDX - Trailing Stop    (1% to 40% trailing stops)
FDX #7

(click to enlarge)

From the above, we see about the same general behavior. As the trailing stop percent increases (#OptVar1), the number of trades declines, even if, in FDX's case, the number of trades starts with a higher number, meaning that there were more trading opportunities. And as a corollary, this implies more price volatility.

#8  FDX - Number of Positions vs APR
FDX #8

(click to enlarge)

The number of trades in chart #8 maintains about the same general shape as in chart #2 which was expected as well.

As for the profit generation, FDX produced:

#9  FDX - Number of Positions vs Profit
FDX #9

(click to enlarge)

So, even though FDX was profitable for every trailing stop value, it never exceeded a 2.0% CAGR compared to a 12.31% for the Buy & Hold scenario based on the same initial capital.

#10  FDX - Summary Performance Report (10% trailing stop)
FDX #10

(click to enlarge)

Doing the same $10k test as with ABT with a 10% trailing stop still did not produce enough to beat the Buy & Hold as can be seen in chart #10. Simply look at the net profit in the first and last column for both scenarios. So, clearly, again, the 10% stake is not enough.

Pushing for full capital utilization as was presented in chart #4 for ABT, the following chart (#11) shows the 100% of equity bets, starting with a $10k bet:

#11  FDX - Trailing Stop with $10k Bets & $10k Reserves
FDX #11

 (click to enlarge)

Here too, as in chart #4, we see a reduction in trading activity due to more restricted reserves, much higher drawdowns across the board accompanied with higher market exposure.

 

More Capital at Play

The next scenario was to put all the capital at play. Meaning putting on 100% equity bets on the original $100k reserves. If you have just $100k, this scenario would be the equivalent to an all-in play in a single stock which is not that great an idea. One building a portfolio should diversify, not just for the fun of it, but simply to spread out the risk. In whatever trading scenario there is always risk. That is why some people make money at this game, it is by taking the financial risks other people are not or no longer willing to take.

At the 10% trailing stop level using 100% equity bets, ABT and FDX produced the following charts:

#12  ABT - Performance Report (10% trailing stop, 100% equity)
ABT #12

 (click to enlarge)

 

#13  FDX - Performance Report (10% trailing stop, 100% equity)
FDX #13

 (click to enlarge)

Both stocks failing to generate impressive results showing that at the 10% trailing stop levels this trading strategy is not worth trading at all.

Their respective simulation reports (ABT and FDX) came out with the following numbers:

#14  ABT - Trailing Stop   (1% to 40% stops, 100% equity)
ABT #14

 (click to enlarge) 

#15  FDX - Trailing Stop   (1% to 40% stops, 100% equity)
FDX #15

(click to enlarge)

The profit distribution charts for ABT and FDX produced the following:

#16  ABT - Trailing Stop   - 100% Equity Bets - Profit Distribution
ABT #16

 (click to enlarge)

#17  FDX - Trailing Stop   - 100% Equity Bets - Profit Distribution
FDX #17

(click to enlarge)

The 100% equity bets with $100k initial capital still underperformed the old standby: the Buy & Hold which required a lot less work than the investigated stop loss trading strategy.

I ran all 10 stocks in the list, the same list as used in The Stock Trading Strategy Experiment. They all performed similarly to ABT and FDX. None outperformed the Buy & Hold, even at the 100% of equity bet level. So, adding more charts would be like saying the same thing over and over again.

 

Conclusion

You often see mentioned in financial literature that one must use stop losses, whereas here it is stated that they might not be worth much. I could run this test on more stocks, but it would not provide more insight, only confirmations of what has already been shown: increasing the stop loss value is certainly no guarantee to outperform the averages. You can win at the game, meaning ending with a profit, but, in all the scenarios presented, the Buy & Hold would have been preferable, and a lot less work.

Naturally, one should still use some forms of stop loss once in a while, but maybe only the kind that gets you out of troubled companies. You are in the business of buying stocks that can prosper over time. Your job is not to hold no matter what, it is however to invest wisely by also putting some common sense on the table.

Why play when you know you will underperform over the long run? Is it for the entertainment or some kind of destructive death wish? A quick look at charts #12 and #13 (the 100% invested with a 10% trailing stop scenario) tends to show how much that kind of entertainment might cost. Take the difference between the net profit Buy & Hold column and the first column.

This type of entertainment can be quite expensive, but if it is what you want to do, all I can say is: it is your ball game, you play it as you wish.

Applying a stop loss scenario as depicted in this article can serve as portfolio protection, but one should also accept that it might be a sure way to underperform market averages. And as such, should be frowned upon.

In the end, you are the one pressing enter, that it be manually or automatically using a trading program.

There are better ways to trade with better trading techniques.

Some worthwhile trading techniques are covered in my ebook where a more elaborate structure is provided. In case you might be interested, here is the Amazon link.

http://www.amazon.com/dp/B01A2M2QFW

The best thing I think anyone should do is: do your own tests. Prove to yourself that what you want to do can stand the test of time, and at the portfolio level.

If you don't do this kind of test, then on what basis could you ever make any claim, really meaning any claim at all. You want to start with an idea you have which has not been tested but that you think should work, well, no kidding, but an idea is not enough. I need more than ideas or opinions when it is related to short term trading. Show me numbers, and overall, they better show some alpha, otherwise I will lose interest very quickly, if not on your very first unsubstantiated "claim".

Best of luck.

 

Second Conclusion

This is more an unsolicited piece of advice than anything else. So, here it goes. Whenever you see someone promoting a trading strategy where they say they use protective stops, may I suggest you run away. Based on all that has been presented in this paper, they are assuring you, declaring in your face, that you will underperform the averages over the long term. They will have a trade here and there that did protect some of the capital, but it won't compensate for the damage done over the long term since you will still generate less overall profits than even the index averages.

You would be better off instead buying index funds where you could do it all yourself at your own pace. At least, you would get about the same as the index average, not below it by design. As always, it is all up to you.

The best way to go might be for you to do your homework, and if you do, you might find that a Buffett style portfolio mimicking his methodology might be the way to go. You will find many examples of trading strategies based on such a Buffett methodology on my site, and it is all free. You might even find some of that stuff interesting.

My preferred stock trading strategy in my collection is currently DEVX8 in its latest iteration. It is designed to accumulate shares over the long term and trade over the process. The generated trading profits are reinvested into accumulating more shares producing a positive feedback loop. It is also an automated long term trading strategy designed to be controllable from the outside if so desired. I think anyone could design such a trading strategy based on their own long term views of the market.

 

All my best.


Created... June 22nd, 2016 © Guy R. Fleury. All rights reserved  

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