Proven Trailing Stop Strategies - Best Percentage To Use & Percentage to AVOID

Summary

In this episode of Market Trends, Matthew Carr, Chief Trend Strategist for the Oxford Club, discusses the importance of using trailing stops for investors to minimize risk and maximize gains. He explains how trailing stops work, providing a step-by-step example using Digital Turbine stock. Carr also shares insights from 10-year simulations, revealing that tighter stops do not yield better returns, and suggests that the optimal percentage for trailing stops varies based on the market cap and volatility of the stock.

Takeaways

• 📈 Matthew Carr, Chief Trend Strategist for the Oxford Club, discusses strategies for improving investment returns while protecting capital.
• 🎰 New investors often adopt a 'gambler's mentality', treating every stock as a potential lottery ticket, which is a high-risk approach.
• 🛡 Trailing stops are recommended as a risk management tool to prevent manageable losses from becoming destructive to financial independence.
• 🔢 A trailing stop is a dynamic sell order that activates when a stock's price falls below a certain level, which is set as a percentage of its peak price.
• 🐶 The trailing stop 'trails' the stock price, moving up as the price increases, similar to a dog on a leash.
• 💡 To set a trailing stop, calculate 75% of the entry price for a 25% trailing stop, adjusting it when the stock hits new personal highs.
• 📉 If a stock performs poorly, the trailing stop ensures that the loss is capped at the predetermined percentage, allowing for a strategic exit.
• 📈 In most cases, stocks will appreciate, and the trailing stop will rise, protecting more of the investment as the stock gains value.
• 📊 Carr's research indicates that the optimal trailing stop percentage varies based on the market cap and volatility of the stock, with no one-size-fits-all solution.
• 📉 Surprisingly, tighter trailing stops (15% or smaller) do not yield better returns and can lead to underperformance due to stocks' natural fluctuations.
• 📈 For large-cap stocks, 35% and 25% trailing stops performed best over a decade, while for small caps, 35% and 30% stops outperformed significantly.

Q & A

What is the main topic of the video script?

The main topic of the video script is about using trailing stops as a strategy to improve investment returns while protecting earned profits.

Who is Matthew Carr and what is his role?

Matthew Carr is the Chief Trend Strategist for the Oxford Club, and he is the presenter of the 'Market Trends' episode in the script.

What is considered a gambler's mentality in the context of the stock market?

A gambler's mentality in the stock market refers to an all-or-nothing approach where every stock investment is seen as either a potential fortune or a complete loss.

What is a trailing stop and how does it work?

A trailing stop is a type of sell order that is automatically triggered when a stock's price falls below a designated level, which is set as a percentage below the stock's highest price reached since purchase.

How does a trailing stop help in managing investment risk?

A trailing stop helps manage investment risk by capping potential losses at a predetermined percentage, thus preventing a manageable loss from becoming destructive and threatening financial independence.

What is an example of how to calculate a 25% trailing stop for a stock bought at $10?

To calculate a 25% trailing stop for a stock bought at $10, you would multiply the entry price ($10) by 0.75 (1.0 minus the trailing stop percentage of 0.25), resulting in a stop price of $7.50.

What happens if a stock's price continues to fall after purchase?

If a stock's price continues to fall, the trailing stop does not trigger a sale until the stock's price closes below the stop price, capping the loss at the predetermined percentage.

How should the trailing stop be adjusted as the stock's price increases?

The trailing stop should be adjusted only when the stock hits a new high for the investor. The new stop price is calculated by multiplying the new high price by the same trailing stop percentage.

What is the significance of adjusting the trailing stop only at new highs?

Adjusting the trailing stop only at new highs ensures that the stop price moves up with the stock's price, thus locking in gains and providing a dynamic loss protection level.

What is the best trailing stop percentage to use according to the script?

The best trailing stop percentage to use varies based on the market cap and volatility of the stock. However, the script suggests that tighter stops (15% or smaller) tend to produce worse returns due to stocks' natural daily fluctuations.

What insights did Matthew Carr provide from his 10-year simulations on trailing stop percentages for different stock sizes?

Matthew Carr's 10-year simulations indicated that for large cap stocks, 35% and 25% trailing stops performed best, while for mid caps, a 20% trailing stop was most effective. For small caps, 35% and 30% trailing stops outperformed significantly. A 10% trailing stop was the worst performer across all stock sizes.