Why risk management, not stock picking matters

From Nick Radge at The Chartist comes this great chart highlighting why you should always have an exit point for selling stocks, and not just repeat the “but the low price = great value” mantra that many confuse with actual investing:

dsh

Dick Smith (DSH) is in the same sorry basket as HIH, Babcock and Brown, OneTel and ABC Learning. There was always a place to get out of the path of the wreckage, even with gap downs after announcements.

Your exit point on the downside should be known BEFORE you initiate a position. Cardinal rule of risk management and comes before working out what or when to buy.

By the way that quote comes from Nick’s book “Unholy Grails” which I heartedly recommend, its in my top five investment books (and no, he doesn’t pay me to say that, its just a damn good book).

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Comments

  1. Yep.

    When I occasionally talk about the stock market with other people (which is hardly ever, unlike property, people in the stock market usually keep their mouths shut) I occasionally get the old line “I thought all you needed was a monkey with a dartboard”

    To which I reply “yep. Give me a monkey, a dartboard and a stoploss”.

    They usually don’t have a clue what Im talking about. And when I explain it to them, they usually still don’t. “But i thought the point was to invest for the long term” etc etc.

    • nice!

      dont mention the fact that random entry strategies usually have an edge over discretionary “expert picking” ones….when applied with risk management

      • “Trade your way to financial freedom” by Van Tharp has a great explanation/examples of this (and many similar techniques).

    • Yeah, but these days your stop-loss is a market order so you have the opportunity to get out at $0 when the robots front-run you through a magically disappearing bid stack before reinstating the price back to your stop-loss level, all within 5 milliseconds.

  2. Nick Radge is top shelf in the system development / share trading / psychology etc.. Great to see him on board here at MB.

    • Sounds about right!
      “Governments show now sign of recognising the limits of what they can do. So they will fail.”

  3. almost the best MB blog post i have read. can’t believe so few comments.

    can’t deny i have been bit lazy with my stops.

    thanks.

    edit: that chart does have some gap downs!

  4. Sure folks but the best way to get out of Dick Smith was not to get into it in the first place. This is where genuine business analysis is required. The fact that so many mums and dads were tipped into it by so called professionals is a disgrace. How much behind the scenes wining and dining went on to ensure the ludicrous float ever got off the ground. Also how much asset relocation goes on at those pitstops along the way down? Key clients out, Mum and Dad and shit bag funds in?? There was nothing random or unpredictable about Dick Smith’s demise if analysts were doing their job. If they couldn’t see this wtf can they see?

    • Yes, stock selection is undoubtedly important. Ideally, one would love to consolidate one’s core portfolio with the likes of Coca Cola, L’Oreal, Philip Morris, Nestle. They almost never trade dirt cheap so one will have to wait for a long time to find any bargain. But then again they will keep making money year in year out so the entry timing may not matter much.

      Stop losses are for trading cigar butts and CFDs. They are useful when the market goes against your initial guesses. The trouble is; what are you going to do when your initial guesses are right? I usually move my stop losses as my positions advance to “lock in” any gains.

  5. I note Peter Switzer was a huge fan, telling subscribers (and presumably his ordinary Mum & Dad superannuation clients) repeatedly and as late as February 2015 that DSH would “deliver”. He’s mates with the CEO Abboud you see; goes to dinner with him and of course (nudge nudge) that’s all the research you need, innit?