The Fixed Percentage Trailing Stop
Investing in Growth stocks is a popular strategy with investors. The strategy provides strong returns while the stock continues trending upwards, however these uptrends can reverse with little warning. The position management strategies used by stock traders with their short-term trades can be easily applied to the long-term trends found with investing.
Position management works best with trending stocks that are expected to continue with their long-term uptrend. The position management strategies generally give poor results with stocks that are not trending.
Using position management strategies changes investing from a passive process into an active process! This may not suit some investors especially those who do not have the time or inclination to actively manage their investments. There is no requirement for investors to use any of the position management strategies. Some investors may simply be interested in the process involved and may consider employing these strategies when market conditions become difficult.
The position management strategies are analyzed using stocks from the Fundamental Investing series of articles. These articles consist of a selection of stocks analyzed for their investment potential and a hypothetical position is taken.
The position entry shown on the COO chart from the December 2014 Growth Stocks article was based purely on fundamental considerations with no regard to the position's entry or its subsequent management. The COO position entry is shown below in Chart 1. without the earnings data.
Chart 1. Position Entry and Initial Stop
As shown in the weekly chart above, COO is a strongly trending stock having made a 5-year high with a current minor pullback.
The first consideration here is position management. For a strongly trending stock a simple but effective position management strategy is the fixed percentage trailing stop.
With this stop method the initial stop is placed a fixed percentage distance below the entry price. The percentage figure to use is arbitrary but values ranging from 5% to 10% are generally suitable for investing. This position will use 10% to give the stock some room to move so it does not stop out too easily with the pullbacks. As a general rule, investors need wider stops than traders since investors are looking for the big moves.
The initial stop is placed at 10% below the entry price.
Once COO starts to rally the stop should be raised (the stop is now referred to as a Trailing Stop).
Chart 2. The Trailing Stop
A 10% trailing stop is used in Chart 2. above. The trailing stop is placed 10% below the highest close after the entry (The closes before the entry date are ignored). Whenever the stock makes a new higher close (after the entry date) the trailing stop is raised to 10% below that highest close.
Chart 3. Raise 10% Trailing Stop
As COO continues to trend higher, the trailing stop is correspondingly raised to 10% below the highest close (after the entry date) as illustrated in Chart 3. above. The closing prices are weekly closes since the charts are weekly line charts. This means the closing price for the last trading day of the week (usually Friday).
Chart 4. Raise 10% Trailing Stop
As Chart 4. above shows COO continues to trend higher and the trailing stop is correspondingly raised to 10% below the highest close.
Chart 5. Stops are Never Lowered
Referring to Chart 5. above, even though COO has pulled back the trailing stop remains at 10% below the highest close and not 10% below the current close. The trailing stop is only ever raised, it is never lowered.
Chart 6. Weekly close below stop
COO has pulled back with a weekly close below the trailing stop as shown above in Chart 6. The stock is sold the next trading day.
The investment gained around 25% over a 21-month period.
Stock Analysis for Finance Students and Investors