Fusion Investor Chatbox

This chatbox is for fundamental, technical and related discussions on investing in Bursa Malaysia. Registration is required to join. Please email me at fusion.investor@gmail.com with your preferred name and password and I will inform you when registration is confirmed.

Disclaimer: As usual, you are solely responsible for your trading & investing decisions.

Wednesday, November 14, 2007

Some thoughts on Stop Loss – CBSTECH

I was chatting with "CJLiew" this evening about CBSTECH and after our chat, it prompted me to write this article.

The background is that CJ and a couple of the other people on the chat box have the good fortune of buying CBSTECH when it was rising the last few days, and in his case, he managed to get some at an amazing price of 65.5 sen which is quite near the recent bottom! Anyway, with CBSTECH closing at 92.5 sen, that’s already over 40% return in a rather short time period. (see chart).

Anyway, originally, he was thinking of disposing this at $1. Today’s opening was 89 sen (a 1.5 sen gap up from yesterday’s closing) which was also the low for the day, rose to a high for 94.5 sen, and closed lower at 92 sen. Originally, he asked for my advice whether he should hold out for $1 before disposing all. Personally, he thought it could make $1.10.

Since I don’t own the stock and has not really followed it from a fundamental perspective, I don’t know. He asked me for my TA perspective.

Sometimes, I do give TA commentaries on the chatbox, but I noticed that often it doesn’t always generate feedback, so, I have no idea whether my comments were blindly accepted or ignored. Also, TA skills is really something one should acquire for oneself, rather than continue to rely on someone else. And after a while, it can get tiring to me as well. So, this time, I thought I’d ask questions instead of parroting out my (probably tiring) opinions.

Our conversation (slightly edited for better reading and clarity) went something like this. Note that since this is a popular chatbox with around 170 registered members and several conversations happening at the same time, it is very difficult to follow the conversation. So, for your simplicity, I have extracted them here.

cjliew: btw seng any chance to help me to look at TA outlook on CBS?

Seng: Well, CJ, what's your take on CBS?

cjliew: my take on CBS is there is strong chance it will take out its all time high at RM1.10 … looking the the way cbs is moving for the past 3 days …but my concern is i think there is a very strong resistence at RM1

Seng: What about today's price action for CBS? Sense some weakness?

cjliew: well high was 94 but it closed at 92 so not bad at all … vol wise day 1 was abt 13K, yesterday was abt 23K but today is higher at 33K

Seng: Well, not bad, but not (perfect) too ... especially if you compared to last 5 days – there (last 5 days) the closing was very strong, right?

cjliew: … the highest vol was 146K … tat was when it hit RM1.10 in july … so i m not sure just rely on vol …

Seng: … (that) is a good observation over the last 3 days ... but I wouldn't put too much (i.e. 100%) significance on things that happened a long time ago.

cjliew: ic so u sense cbs is toppish at 94.5? … i was thinking of selling tommorrow at near RM1 … wat do u think?

Seng: Well, to keep it simple, to me, ... today, we just saw the first day of possible weakness. That's a sign to pay attention to.

(It’s natural to) have "hopes" of (the price) repeating or exceeding previous high. But as a trader, you need to put those "hopes" aside (and focus on the price/volume tomorrow). (In particular, …) observe for price weakness. (When you see them,) be prepared to get out or get smaller immediately. E.g. at this stage of the game (with such a strong run-up), I would want to see good volume in the first half tomorrow (or earlier) ... if there isn't it's time to get smaller. Basically, if you sense some uncertainty, it's time to get out or get smaller. you can't pick the top always, but you can get smaller. E.g. what stop loss do you want to set for CBS?

cjliew: well my cost is 65.5 so sitting in a profit position … i just dont want miss the boat loh

Seng: Right, but you want a trailing stop loss which is better. To wait until it fall to 65.5 sen and then sell is too late. You'll be committing a very bad principle of turning your profits into nothing. So, you'll need to raise your stop loss to a higher price.

cjliew: any suggestion?

Seng: Well, what does the charts tell you as a possible support level?

cjliew: i m consider a newbie

Seng: Well, what about today's intra-day charts - does it give you any hint where you should put your stop loss? (the point of asking this question is not that stop loss should be automatically based on intra-day charts, but to get CJ to do the work himself – notice how I consciously didn’t want to give an answer).

cjliew: ok i m not very good at this i think the support shld b at 88 … then follow by 80 ctns … which is the high for the past 2 days …

today's low was 89 and high was 94.5 … so stop loss at 90 ctns?

Seng: CJ, that's fine since there's no single right answer. But there are some answers which are more "obvious" than others. E.g. recent low is one. The other is Moving Average supports. The other is recent highs (that are lower than current price). These are some of the obvious ones.

cjliew: so stop loss at 90 is right? …

sorry seng i m just trying to ride on the gain as high as possible … may b u can share wat shld b the stop loss price?

Seng: As a trader, it is important to keep it confidential to only yourself the exact stop loss level. never make it public, because (price manipulators or) syndicates can (potentially) take advantage of this. But basically, pick a point where it is slightly below obvious levels, or sometimes, above obvious levels (the goal is to vary it so that it is not obvious) . Basically (you have alternatives – e.g. one possible thing ) you could do when the upward momentum is still strong is not to execute your stop loss in full. instead, sell say 50% (or another multiple, which can be up to 100%) at the (first) predetermined stop loss level. This may not be optimum, but should let you ride at least 80%-90% of the upside.

Seng: E.g. if (and it can be a different number), you decide to have a stop loss at say 88 sen, then, when the price hit 88 sen and is going down fast, you put a sell order to sell at 87.5 or even 87 sen for half of what you got. You just must run (execute your first stop loss) at all cost and fast. Then, wait ... if it keeps falling to 80 sen, and let say your 2nd stop loss level is 80 sen, this time, you don't have to execute it hard because you already got half out at 87 sen. The first stop loss is often not negotiable, but in this situation (where you have lots of profits), the second one, you can give a bit of leeway depending on downfall strength (although not encouraged for beginners), because sometimes, manipulators do this to scare off the weak holders. but I don't have a necessarily fixed strategy for stop loss.

E.g. if price falls below 80 sen, this means you got out 50% at 87 sen and 50% at 80 sen, with an average out price of 83.5 sen. You have protected a lot of your gains since your buy is 65.5 sen. It is decent for a stock that makes a rapid decline. And if your first stop is hit but your 2nd isn't, you've bought insurance and can ride the rest up without fear. The key is never turn a profitable position into a losing position. If you can do this, you'd be hands up above a lot of other people.

In other words, by tomorrow morning, you must already know for yourself 2 important numbers (= the 2 stop loss levels). And when you watch the intra-day ticks moving tomorrow morning, it's a chance for you to revise your stop loss levels. Remember, stop loss levels can never be revised downwards, only upwards. … Even if price falls much faster than you can catch, you must execute it to the best of your ability. Else, you'll be in trouble.

Seng: I nearly got into trouble with my Petroch-C1 (recently) .. I made a mistake of giving a bit of leeway to my first stop loss of $1 that Monday morning. but when it fell below that fast, I execute it fast and only managed to get out completely at 95 sen. And that act protected me a lot, as you can see today (51 sen). If you find this skill a useful one in future, then, I hope you use any future profits to make this world a better place for us to live in ...

Another reader commented on this, which is why I am writing this article for future reference.

ks: Seng if u would hv mention abt this stop loss method earlier,I would not hv lose back all my Petro c1 gain sob sob

So, that’s roughly the gist of our conversation. I don’t pretend that I gave the best possible response, as this is just a chit chat sandwiched in between other conversations, and I haven’t really stopped and think critically how I should best phrase my responses as they are off the fly. So, there could be valid criticism to this sort of advice.

Upon writing this, I reflect a few additional things:

1. There is nothing necessarily wrong to sell on strength as CJ originally planned. E.g. the market might give him the chance to sell at $1 tomorrow, and this could be better than 50/50 chance in view of the recent momentum. Perhaps it’s worth mentioning that the risk of course is that if he sells at $1, and it then goes up to an even higher figure, then, he might kick himself for “selling too early”, whereas a properly set stop loss still allows full exposure to further orderly upside and limiting downside risks.

2. But countering 1. is that price rises tend to be more gradual (although CBS price rise in last few days is anything but gradual), whereas price downfall tend to be very quick, so, for someone who can’t monitor every minute during trading hours, maybe it is a better and more practical strategy to just sell some on strength. E.g. take a quarter’s profit (or another number), and leave three-quarter’s on the table to bring the average cost down to well below 62 sen. (Aug 17 close).

3. It is often said that “the first stop loss is often the Best stop loss”. So, someone might argue that my advice to sell half on the first stop loss and another half on the 2nd stop loss might not be efficient. That’s true, and I won’t debate which is better since this is an individual decision. If we all have the same decision, then, the price manipulators can easily manipulate the market. Let’s make his job a little bit more difficult …

4. I suspect many CBS players will be "hoping" for a repeat of 9 Jul where volume topped 14.6 million and the price rides to a wonderful $1.10. That’s a natural hope - it could happen, and $1.10 could even be exceeded. But let's not kid ourselves. At the time of writing, all this is is just "hope". And in serious trading, “hope” really has no place during trading hours. During trading hours, never be stubborn and cling to “hope” when the price action shows otherwise (even when volume action shows a repeat). Always listen to Mr Market, and never try to argue with him.

5. During trading hours tomorrow, please don't ask me whether it is time to execute stop loss - you won't have the time.

6. Remember that all numbers mentioned here are simply hypothetical. You must assume the price manipulators exist, and have read this article, and not only that, but have already planned what to do in this coming days when it comes to distribution time. So, keep your stop loss and your plans confidential. I would prefer if the chatters would not adopt the alternative strategy of confusing readers in the hope of confusing the price manipulators, since this latter strategy have the effect of misleading innocent readers.

Anyway, I personally don’t have any position in CBS (which is why I can write this article with full conscience). As usual, trade (buy, hold, sell) at your own risks.

Happy Trading and don’t forget your stop loss!

Saturday, November 10, 2007

Lower Unregistered Chatbox Removed

As you will have already noticed, I have removed the previous "lower unregistered chatbox". If you have been following this blog every day, then, you will already know the reasons.

For those of you who don't, my original purpose in setting the chatboxes was a positive one, and it still is. Amongst other things, it is to promote a positive learning environment, to promote constructive discussions of mutual topics of interests, etc. However, it is clear especially in the last fortnight, that it has not only failed to achieve any of these positive objectives, but instead fostered destructive comments.

One individual, who called himself by various names - "snail", "lansi", and later morphed into respected members of the above boxes by calling himself "newbie", "bullbear", etc. - was very persistent in "spamming". He has been spamming persistently - nearly everyday over the last fortnight, as well as in the past. Each spam typically blocks out the entire conversation of the chatboxes with multiple comments of the same message, sometimes up to 20(!) identical comments to completely block out the chatbox, leaving only his spam. This typically happens at least once a day, sometimes twice or even three times a day! Over the last fortnight, easily 80%-90% of the entries are his alone.

I don't keep a copy of the contents of the spams. Suffice to say they are destructive and in no way useful if one is genuine to seeking improvement to his investing results.

Actually, I thought that some of the spam contents could have been interesting topics of discussions. I invited him to discuss rationally several times. He would ignore and sometimes, even increase the intensity of the spam, personal attacks and verbal abuse.

Everyone in both chatboxes tried to ignore him, but his persistence in spamming eventually got some fed up. Attempts to tell him to stop fell on deaf ears. Kind and generous advices were ignored and received intensified abuse. A few - perhaps out of desperation - gave him a small dose of his own medicine. That made it worse and created a war. If you think I was describing a verbal warzone, you would not wrong - the words used by and to describe lansi are crude and disgusting to say the least.

Whilst I am appreciative of the many supporting comments and attempts to return the lower cbox to sanity, it had become tiring and impossible for everyone.

Chances were given many times to stop or discuss rationally. Finally, after the most patient trying attempt, last night, I let him decide whether he want to stop or face the consequences (that the cbox would be removed if he continued his antics).

When I logged in this morning, he chose to continue his irresponsible behaviour without care nor regard to the rest of the online community. Hence, I had no choice but to remove the chatbox. It is a real shame that he had chosen to do this.

Notwithstanding this, the person is still most welcome to present his views here. All he has to do is to register with me to chat at the top chatbox. And I can still be contacted on my email - fusion.investor@gmail.com - as stated above. I would urge him to be respectful to everyone there. Basically treat others how you would like to be treated. Certainly, irrational and irresponsible behaviour has never been, and will never be acceptable nor welcomed in this blog.

Take care and happy trading!

Friday, November 9, 2007

Some thoughts on Position Sizing

“[Soros taught me] it’s not whether you’re right or wrong that’s important, but how much money you make when you are right, and how much you lose when you’re wrong.” – Stanley Druckenmiller

When novice invests in the stock market, they are usually full of hope and optimism. They tend to only consider the upside (and target price), and usually ignores stop loss, before putting on the trade.

Perhaps this is due to the prevalent myth of a “perfect stock-picker” or “perfect stock-tip” – the perfect investor or tip that always pick winners and never makes mistakes. Sadly, that is a myth. Invest long enough, and soon, everyone will have a loser in his hands. This is stock market reality. Show me someone who has made 100 trades with 100 winners and he/she is a liar. :-)

It is not common to read this, but even the Best of the Best, the master investor and the world’s 2nd (or 3rd) richest man – Warren Buffett – has made his share of investing mistakes and continues to do so even today. Don’t believe me? Well, take a look at this site and look at the first entry – BAC (Bank of America). BAC is a relatively recent purchase (mid this year), and to date, Buffett has an unrealized loss of 13%. So, even the Best in the world still makes mistakes.

So, if Buffett continues to make mistakes, and we lesser mortals also make mistakes, how is it that Buffett has managed to amass such a huge amount of wealth that far exceeds our own experience let alone our wildest imagination? Remember that Buffett starts from nothing, like most of us. What is it that truly separates Buffett from the vast majority of investors?

Well, we’ve heard many reasons mentioned elsewhere such as his unparalled ability to determine intrinsic value of a business, margin of safety, ability to accurately assess business future prospects and risks, ability to assess management honesty, integrity, competency, understand company financials and business models, amazing memory, his infinite patience to wait for the “fat pitch” even if it means waiting for decades for the right opportunity to come along, his people and business management skills, etc. etc. etc..

But despite all these wonderful abilities, the bottom line is he still makes mistakes. Period. His recent BAC purchase is a timing mistake – 13% loss. His recent Petro China sale at $12 which is well below the peak of $20 is a timing mistake. And many, many more. But despite these mistakes, how is it that he is worth billions of US$ and his millions of “twin investors” (in the same 55 years investing period) aren’t ?

I believe the main and the least understood reason is because he is also a Master in “position sizing”. Bottom line is that when (not if, but when) he makes mistakes, his mistakes tend to have minimal impact on his total capital. But when he is right, his bet has a huge impact to growing his net worth. He aims to preserve capital and score home runs by only betting big in situations that he has the most confidence in. And he avoids bets that don’t meet his strict criteria. When he is winning, he adds more to his winning positions including not selling his winners which has grown to become even bigger % of capital over long periods of time (e.g. Coca-Cola). When he is proven wrong (e.g. adverse earnings results on Pier 1), he doesn’t throw good money after bad ones by averaging down, but instead sell out.

Buffett is well known to have infinite patience and waiting for the “fat pitch”. What does a “fat pitch” means? Well, it is a baseball term, where the batter will only swing at the ball when it is at the most favorable zone. In other words, he will swing only when the ball is at the ideal position for the batter to score a home run. He will not swing until he gets the perfect pitch, or the “fat pitch”. In other words, he will only invest in situations that meet his strict and successful criteria.

But occasionally, he will be presented with more than 1 opportunity that meets his criteria. E.g. he may be looking at several eligible opportunities, each with different % return on capital. In such a situation, I believe Buffett will automatically puts bigger amounts on the higher % return on capital opportunities subconsciously and without hesitation. His frequently quoted yardstick is to always compare with his best existing investment (such as Coca-Cola). He will not invest in a new venture if the return on capital is lower than Coca-Cola. Instead, he will prefer to add more Coca-Cola if the pricing is right.

It is also worth noting his “buy and hold forever” approach. When he is right and a stock price starts to appreciate, does he sell? Unlike most of us, he doesn’t sell. Again, Coca-Cola is the most obvious example. He has held that stock for decades now that Coca-Cola has grown to become the number 1 stock holding for Berkshire for many, many years. As Coca-cola grows to become a higher % of Berkshire’s capital, he is happy to do nothing and just let his winners grow. He is not concerned that Coca-cola has grown to become “too large” a % of Berkshire’s capital. All he is concerned about is making a meaningful amount of money when he is right.

And indirectly, this is also a passive form of “position sizing” for him, since he continues to hold even bigger positions in his long-term winners like Coca-Cola which continues to make even more money over time.

So, what can we learn from the above? Can we break down the main principles of position sizing? How do we mortals decide how much to invest in a trade? To me, mathematically it boils down to 3 things:

1. The odds of winning and losing. Other things equal, you want to bet larger amounts in trades with the highest odds of winning. This means you must acquire and learn the ability to distinguish and rank trade opportunities since not all trades have equal odds all the time. And you want to avoid trades where the odds are simply 50/50 when you are simply uncertain. Here, Kelly’s Optimization Formula for even-money bets may be useful for value investors who like the precision of mathematical formulas. http://en.wikipedia.org/wiki/Kelly_criterion. In fact, the Motley Fool calls it “the Most Important formula in investing”. See http://www.fool.com/investing/value/2006/10/27/the-most-important-formula-in-investing.aspx.

2. Risk/reward trade-off. Besides the odds of winning and losing, there is also the amount which one expects to win when one is right (=Reward), versus the amount that one expects to lose if one turns out to be wrong (Risk Amount). Value investors demand bigger margins of safety to bet big, since the bigger the margin of safety, the bigger the potential reward and the smaller the risk. Traders sometimes calculate these as Reward = Target Price – Current Price, and Risk = Current Price – Stop Loss price. Mathematically, there is no real distinction between how a value investor and a trader calculates Reward – the difference is definition and semantics. Basically, other things equal, you want to bet bigger amounts when the Rewards substantially offset the Risks. The Kelly general formula gives an optimize formula to maximize equity growth to determine this.

3. Your accuracy in assessing 1. and 2. above. In the investment field, there are surveys and studies that show that most investors tend to over-estimate their ability in sizing up the winning odds, and tend to under-estimate the odds of losing. It’s a bit like surveys showing that most drivers tend to think that they have “above-average” driving skills – this is clearly impossible, since objectively, “the majority cannot be above-average”. For value investors, a formula like “half-Kelly” (or a fractional Kelly) could be useful here, to compensate for the initial over-estimation. As one becomes more competent later, the formula could be fine-tuned to tailor to the individual.

Whilst Kelly is typically applied to value investors, the 3 principles above can also be applied to traders, although the details usually differ due to the different approaches. E.g. for 1., some traders avoid trades with less than 60% (or another %) chance of success and only focus on trades with more than 60% chance of success, based on technical charts or some other criteria. For 2., some traders avoid trades when the Rewards are less than twice the Risk (or some other parameter). For 3., the actual position size is sometimes calculated based on a constant % of capital at risk approach (instead of Kelly’s). Basically, this approach starts off by setting a certain fixed % of capital which a trader is willing to lose from a trade if his trade goes wrong – typically, 0.5% to 2% of capital. E.g. if one has $100,000 capital and one is willing to risk 1% of capital or $1,000 in the event of a stop loss, then, the amount one would invest will depend on the gap between current price vs the intended Stop Loss. If the Stop Loss is near the Current Price, the position size is larger than if the Stop Loss is further away from the Current Price. E.g. if Current Price is $1, and Stop Loss is $0.90, then, the number of shares to buy = $1,000 / ($1 – 0.90) = 10,000 shares = $10,000 = 10% of capital. The idea is that if the stop loss is executed at $0.90, the loss = 10,000 shares x 0.10 loss = $1,000 = 1% of capital. This assumes perfect stop loss execution with no slippage. In reality, some allowance must be made for these. Depending on the perceived odds, they will vary the amount of capital at risk, such that on trades with the most confidence, one may place more capital at risk, and vice versa.

Some Concluding Comments

The concept of position sizing is not usually obvious to beginning and average investors. It is only too common to hear the average Bursa investors asking their tipster or “gurus” WHAT stock to buy. Visit any investing blogs with chatboxes, and the most popular question when it comes to tips by far may be “WHAT STOCK to buy?” The second and third most common question is “WHAT PRICE to buy and WHAT is the Target Price?” It is less common to hear “what is the stop loss price?”. And perhaps a question that we almost never hear is “how much” to buy, or what % of capital to buy. And unfortunately, the last question may in fact be the most important question of all, in terms of the impact on total equity growth.

Why? Well, imagine you’ve made 3 trades – the first 2 successful and the 3rd unsuccessful (67% success rate is not a bad rate). Let’s say 10% gain, 50% gain and 5% loss respectively. If your largest position is the 50% gain, then, you should come out well on your total equity. But if your largest position is the 3rd trade with 5% loss, and your first 2 trades are very small positions, then, you can actually end up with an overall net loss. Despite scoring 10% and 50% gains!

Don’t believe me? Well, prove it to yourself mathematically. Imagine you invest $3k each in the first 2 trades. And imagine you invest $50k in the 3rd trade. Your net loss is 3000 x 10% + 3000 x 50% - 50,000 x 5% = - $700 (or $700 loss).

So, in conclusion. As you become more competent in investing and trading, pay more attention to position sizing. Better, learn from the masters (whether master investor or master trader) how they approach the issue of position sizing.

On a personal note, I want to share with you my own personal investing experience recently which has convinced me the importance of position sizing. I am very proud to say that my recent Petrochina Call Warrants trades have given me the largest $ gains I have ever had from a single investment ever in my entire life. Petroch-C1 has the most amazing run from a low price of below 5 sen on Aug 17, to a high of $1.11 on Nov 5. I first entered PetroCh on June 8, but it was a very small position. On Aug 17, I managed to get a very small position at rock bottom prices, but sold too early, and then, kept buying more on its way up. On Nov 2, PetrochC1 & C4 represented nearly 30% of my entire capital! (this is by far the largest amount I have ever had on a single stock, when my previous principle is never to have more than 5% of my capital in any single stock, let alone a Call Warrant!). Finally, on Nov 5, due to its uncertain price action, I decided to sell all of my Petroch-CW holdings at around Nov 2 closing prices. In $ terms, the returns from Petro CW alone (in 3 months) is more than 3 times my largest gain to date then (MAYBULK, after nearly 2 years of value investing). There are 2 critical lessons for me from this experience. First, when you are right about a stock, don’t be afraid to keep adding more on its way up – I was adding Petroch-C1 at increasing prices, even when it was trading at 80+ sen at new highs. I have actually done this many times before with other stocks, but the difference with Petroch-CW is the stark difference in “position size” – I was around 80% confident in Petrochina, and according to half-Kelly’s formula, I should aim to have around 30% of my capital in it. Second, when you are in an uncertain position – and this happened on Nov 5 when the mother share could not sustain its rise past $20 – I quickly liquidated as much as I can. I had no business playing CWs when I am uncertain on its future outlook – again a Kelly formula with 50/50 odds suggests nil holdings. Again, I have practiced this many times before, but the difference this time is that I am willing to let go 100% (or as close to it as I can) when I am uncertain, as opposed to the normal practice of retaining half. And this is an important aspect of position sizing too. As a result of an overall much improved position sizing experience from entry to exit, I have already observed a substantial and almost immediate improvement to my own personal equity results.

It is also worth noting that I did reenter Petroch-C4 at prices between 65 to 70 sen after Nov 5 (after having sold them at close to 90 sen on Nov 5), but this time, because the outlook is much less certain, my position size is much smaller at less than a third of my original Petroch-C4 position. Naturally, I am expecting a worse price tomorrow due to the prior day weakness in HK, but in the worst case scenario (assuming I can execute my personal stop loss without much slippage), I still expect to keep around 90% of my Petroch-CW gains. From my peak gain in total equity in late July, my total gain is now close to double the peak in roughly 3+ months as a result of improved focus on position sizing. Naturally, I am happy with my Petroch-CW gains, but the personal satisfaction of a successful trade with improved position sizing is beyond description.

Good luck in your future trades.

Disclaimer: As usual, trade (buy, hold, sell) at your own risks.