Revealed: A trailing stop loss in action

Fsp Invest, 18 Sep. 2013

Tags: trailing stop loss, protects, investments, how to protect your investment, trailing stop, example of a trailing stop loss working

Trailing stop losses are a great way to make sure that you don’t lose too much of your money in a stock. Not only that, but a trailing stop loss lets you make the most out of a share that is rising in value. Read on to find out how a trailing stop loss works…

A trailing stop loss works as follows, the team of experts at Investment U explain…

The main element to the trailing stop strategy is a 25% rule. You sell positions at 25% off their highs.

For example, if you buy a stock at R50, and it rises to R100, when do you sell it? When it falls back to R75, or 25% off its high.

How a trailing stop loss strategy protects your investment

If you do hold onto a falling stock too long, the loss will often be far more than just 25%. And all it takes is one big loss to set an investor back for years.

Let’s say you start off with R10,000. A year later you’ve made 25% (R12,500). Same for next year (R15,625), and the next (R19,530).

But then after three years of 25% annual gains, the fourth year, you take a loss of 50%. It puts you back below where you started, at R9,766.

Now, let’s say you had a 25% trailing stop during the year you lost 50%. You would have sold your shares at R14,648.

Then during the following three years (when you again profited by 25% each year), your holdings would be R28,600 at the end of that entire seven-year stretch.

However, if you didn’t have a 25% trailing stop in place, after the same seven-year period, you would only have R19,073, still below where you were prior to the 50% drop!

Over the seven years of this example, you’d be up 186%. That’s an average return of over 26% per year, much better than you’d think.

But pick your own example, and do the maths. Look back at your own portfolio. You’ll see that cutting your losses is the key to both getting good overall returns and avoiding lost years.

So there you have it, how a trailing stop loss works.

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