How to Use a Trailing Stop - $ORCL

For small investors with self-directed brokerage accounts, there are automated tools to help mitigate losses, when 'the market' or a particular equity turns negative.  A Trailing Stop is one such tool.

Of course all investors are happy when the value of their investments are going up, generally watching that upward trend in the hope that it will continue!  Unfortunately, when ‘the market’ goes down, they sometimes run scared of taking losses and often, most unfortunately, sell their stocks at market lows, at a loss.

The primary reason for the behavior described above is emotion.  Secondary reasons include procrastination, greed, a lack of knowledge about investing, and more.

Since everyone is generally happy when his or her investments are posting gains, let’s focus on how small investors can mitigate downside risk.

One of the most useful tools I’ve seen (and use frequently) is Trailing Stop functionality offered via my self-directed brokerage account.  Trailing Stop is a fancy name for a ‘stop-loss’ order that trails an equity’s price.

According to Investopedia: “This is such a useful tool, yet many fail to use it. Using a trailing stop allows you to let profits run while cutting losses at the same time.”

By way of a practical example, let’s take a look at Oracle ($ORCL) at the time of their earnings release of March 20, 2013:

1.     For most of the earlier part of the month $ORCL traded in the mid-$30’s.

2.     After market close on 3/20, $ORCL announced financial results for Q3.

3.     Revenue for the quarter was $9 billion; non-GAAP EPS, 65 cents.  Analysts were expecting revenue of $9.37 billion and non-GAAP EPS of 66 cents.

4.     $ORCL had closed at $35.76 on March 20. In after hours trading, the stock hit $32.30 and by March 25^th, $ORCL was trading at $31.25.

A year earlier $ORCL was trading at around $28.00.  Using the Investopedia “let profits run” analogy above, the return of a long position in $ORCL over one year (at the then current sales price of $36.00) would have been close to 30%.

An investor who bought $ORCL at $28 could have entered a Trailing Stop order at e.g. 3% (Trailing Stops can also be entered in dollar value instead of a percentage).  In simple terms, decide up-front how much of your investment you would be willing to lose.  

A ‘trailing stop-loss order’ of 3% would have followed (or trailed) the upward growth in the $ORCL stock price, that's why it's called a Trailing Stop.  If the stock priced dropped by about $1 (e.g. 3% of $35), the trailing stop order would automatically have become a market order, the position would have been closed at $34.00... and the investor would have cashed a gain of >20%.  Cash that becomes "cash awaiting investment."

Conversely, if an investor had bought $ORCL at $28, plugged in a 3% Trailing Stop, and the stock dropped shortly thereafter by more than 84 cents (3% of $28), the automated market order triggered by the Trailing Stop would have capped the loss, within a range that the investor had pre-determined to be acceptable, as suggested above.

When you invest, you do plan and determine upfront what amount of loss you are willing and able to accommodate... right?

Here's one caveat, and the reason why I chose $ORCL for my example.  If an investor had plugged in a Trailing Stop order of 3% and the stock dropped by 10% in after-hours trading, the Trailing Stop would have executed at the opening price the morning of the following business day, or $32.20, as above, actually executing at a price lower than the stop-loss price or percentage, e.g. 3%.

Therefore, if one had held $ORCL long for a year (bought at $28), even an after-market-hour closing price ‘crash’ of 10% would have allowed execution at $32 to cash/bank a profit of 14%.  Remember, no one has ever lost any money selling something for a profit, even a small profit!

An additional benefit of using a Trailing Stop order is that – more often than not – one is able to cash gains, allowing you to buy back into that same equity at the (now) lower price.  Because the investor avoided selling the stock at a loss, buying back into the same equity – while on sale – avoids the further cost of a ‘wash sale’, but perhaps that’s a topic for a future discussion. 

Happy trading, and best of success!

Here's a graph showing the history one year prior, courtesy YCharts:

Communistic States of America?

The other day I watched Australian born comedian, Jim Jefferies, doing some stand-up shtick. 

Jefferies joked and talked about the U.S., mentioning that although this country is ranked about 27^th in the world in terms of education (literacy, math and science), it is still ranked #1 in confidence.  Now, let’s think about that for a minute… wouldn’t it perhaps be better the other way around?

A little humility can sometimes go a long way to make up for stupidity.  I know this from personal experience.  I’ve also tried both, and humbleness trumps stupidity almost every time!

I currently live and work in San Francisco, but my home is in Florida.  On Saturday, July 6, I am going to see Jim Jefferies live at Cobb's.  Once again - I'm sure - he will get me thinking and laughing all at the same time with his hilarious thoughtful insults, and psychological body blows! 

During the last five years, I have lived and worked in Toronto Canada, and four U.S. States: CA, CT, NJ and FL.  I probably therefore have at least a little standing when it comes to global mobility; especially as related to general work and play.

Top L to R, clockwise: Prague Castle, Prague street scene, Budapest street scene, Budapest city view down the Danube

Last week I returned from a trip that included a visit to some Eastern European countries, including the Czech Republic, formerly known as Czechoslovakia.  For 41 years following the 1946 elections this country was under communist rule.  This extended period was characterized by lagging behind the West in almost every aspect of social and economic development.

I also visited Hungary.  Following the fall of Nazi Germany, Soviet troops occupied all of the country, and Hungary gradually became a communist satellite state of the Soviet Union. It was a communist state from 1947-1989.

Given the information above, one would automatically assume that these two countries mentioned immediately above are somewhat ‘backward’, can perhaps be viewed as developing nations, etc.  This would be entirely correct, subject to one’s benchmark or measurement in this regard.  To support this hypothesis, I can offer that the average annual wage is around US$ 20,000.  That’s about 1/3 of the wage of a sanitation worker in New York City, just for some perspective. 

For better perspective then, a sanitation worker (or garbage man) in NYC may be ranked about equal (or below) the level of education of the people from these recently converted communist countries.  But, Mr. U.S. sanitation worker would be way more confident, as described above. Yes, it's a generalization, but I'm sure you get the point I'm trying to make.  

 Is artificial U.S. confidence still justified… or, was it ever?

The Eastern European countries – in addition to the stunning architecture, charm and character of hundreds or thousands of years of history – are actually not only on par, but perhaps even ahead of the U.S., in some general terms.

The technological automation and general cleanliness of Prague, and especially Budapest, easily trumps the crumbling infrastructure and visual dereliction that can be observed in San Francisco, for example.

The latter features rampant homelessness complemented by all its related social ills, miserable - but highly compensated - toll booth operators, ‘rapid transit’ desperately in need of an upgrade, etc.  This despite a recently announced $7.9 billion city budget – arguably a high cost for running a small city with less than 1 million inhabitants!

Comparatively, the two ex-communist cities are clean, feature modern trams, technology far more advanced than what can be found in most U.S. states or cities (e.g. bank machines featuring 5 or more languages, electronic toll vignettes that displace people and transponders, etc.).

Visiting these Eastern European cities was an eye-opener for a city slicker from Silicon Valley!

Has the U.S. slowly lost its edge… or are we about to witness the greatest macro-economical comeback story in history?  I sure hope it will be the latter!