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The Upside Maximizer

by Lobo Tiggre
Friday, December 06, 10:35am, UTC, 2019

Back when Porter Stansberry bought a majority interest in Casey Research, we had a meeting about my work. He pretty much told me to keep doing the great job I was doing, and asked what resources I need to do it the best I could—which he then provided. His one critique was to ask why I never used stop losses.

My answer was exactly what Doug Casey had taught me: the junior mining stocks we usually speculate on are too volatile. They can fluctuate 30% or more in a day, just because one major shareholder gets a margin call. Even a 50% drop could be a great opportunity to average down, depending on the circumstances.

Porter said he understood, but that for the larger companies then covered in BIG GOLD at least, we should use trailing stop losses. (That means constantly revising the stop-loss trigger upward as a share price rises.)

I don’t remember his exact words, but I remember very clearly that he insisted that we must not blow up our readers’ portfolios with massive losses if our trades go against us.

A single trade going to zero might be survivable, but if, for example, we got the trend for gold wrong in a big way, most of our stocks would tank. We would subject most of our readers to massive losses, which was unacceptable.

That made sense to me, so we gave it a try.

 

One Size Does NOT Fit All

I don’t have access to my former track-record data, but my memory is that the experiment… did not go well. The stops kept getting triggered before the stocks moved up enough for them to lock in gains. The phrase “resounding failure” comes to mind.

I remember only one instance when a stop loss saved us from a bigger loss. A market fluctuation stopped us out of Tahoe Resources a few months before that company’s flagship Escobal silver mine was shut down by the courts of Guatemala. But that was random. The fluctuation that stopped us out had nothing to do with the later political lightning strike. And had the mine not been shut down, the fluctuation that stopped us out would likely have been a great buying opportunity.

I remember one just like that. A miss one quarter stopped us out of Teck Resources. I hated to sell the stock because I was convinced of the soundness of the company and our speculative premise at the time. I was sure it would rebound. But if you know me at all, you know I believe that discipline pays, so I closed the position. And of course, the stock took off and rose strongly for the next year or so.

At the end of the day, taking some big hits—even total wipeouts—is part of the “basket method” of speculation Doug Casey taught me. Done right, the high-multiple winners more than offset the losses. (See my free Speculation 101 report for an example.)

And I’ve seen mining stocks tank and then go on to deliver big wins for those who held. What would be a disaster beyond recovery in other investments is sometimes just a bad year for a mining stock. Quite a few showed exactly this during the crash of 2008 and the rally afterward.

In my experience, even the biggest gold miners are just too volatile for a conventional stop-loss strategy. Apart from Tahoe, my experiences with stop losses are more like that with Teck: snatching defeat out of the jaws of victory.

That was an important lesson. Today, I never use any system that sells my stocks for me automatically. Even when I do set triggers, I evaluate the market and the stock at that time and make my decision myself. Think first, then act. I sell if I have good reasons to sell, not just because some arbitrary number was triggered.

 

A Different Approach to Limiting Losses: Humility

That said, I have learned to be quicker to admit it when I get a trade wrong or that a trend has turned against me. I sure don’t want to inflict any massive losses on my readers—or myself, now that I have 100% skin in The Independent Speculator game. I plan to be more humble about taking my losses and moving on rather than riding a falling star all the way down to the rocky bottom of its death crater.

A case in point was me selling Fortuna Silver this year at a modest loss. I really like the company. I was very tempted to hold it, hoping that the new government of Argentina wouldn’t be as criminally stupid as the last time Kirchnerites were in power. But the reality is that there is no basis for this hope—and plenty of reason to expect the contrary. I could be wrong, but I’m just not willing to take the risk of that stock cratering if the new government turns out to be psycho.

Bottom line: I fully intend to avoid taking big losses.

What remains to be seen is whether I’ve improved enough as a stock-picker to make this happen. So far, so good on my new track record.

 

The Upside Maximizer

While using stop losses to prevent losses didn’t work for me, the idea of a trailing stop loss to lock in gains has.

Doug Casey taught me to sell half on the first double (a practice Marin Katusa later dubbed the Casey Free Ride—CFR). Doing so results in getting all of one’s initial investment back out of potential harm’s way while retaining the same upside one started with. Great for sleeping well at night.

The problem with then CFR formula is that it turns 10-baggers into 5-baggers, doubles into 50% wins, and so forth.

But staying long after the first double keeps all the risk in the play. No gain is an actual win until shares are sold and profits realized. Having a fortune within grasp that could evaporate at any second is no recipe for sleeping well at night.

Enter the trailing stop loss… though, since I’m not using it to prevent losses but to lock in gains, the strategy should really be called the Upside Maximizer.

When a stock becomes a winner, the Upside Maximizer strategy is to put a trailing stop loss on it, rather than take profits or recover initial investment. Unlike the CFR strategy, this doesn’t automatically cut the remaining upside in half. We still own the stock as long as it continues to rise within its normal range of volatility. If it goes up 10x before correcting sharply, we get our full 10-bagger.

Of course, few things ever shoot up 10x without some serious retreats along the way. I’m not sure I’ve ever seen that happen. A trailing stop loss that actually did its job of locking in gains would likely be triggered long before a stock rose that high.

But let’s say the first big correction hits a smashing success story when the stock is up 200% or 300%. If we recover our initial investment then, we still end up with a much bigger win by the time the shares do go up 1,000% than we would if we sold half on the first double. And we still get to sleep at night.

The only case in which this strategy underperforms the CFR formula is if the stock drops after doubling without rising any further. That precise a peak at 100% may be as rare as a stock that goes up 100% without any serious correction along the way. And the difference between CFR and the Upside Maximizer in this rare case isn’t that much, so I’m not going to lose any sleep over it.

 

Upside Optionality

Better yet, we have options when a profit-maximizing trailing stop loss is triggered on a big win. We can…

  • Sell entirely and move on.
     
  • Recover only our initial investment and leave most of the money exposed to the remaining upside.
     
  • Take more profits, cashing out a bigger initial win, but still leaving some money in the play.
     
  • Sell some amount in between (as needed for kids’ college tuition, or for a new speculation, etc.)

How I play this has to do with the level of risk I perceive in the speculation going forward.

If the company is having problems or the country risk has risen since I bought it, I’m more inclined to sell outright or take a larger portion of profits.

If I really like the play better than ever, I’m inclined to take minimal profits to retain maximum upside.

To each his or her own, of course, but even the highest-risk use of the Upside Maximizer strategy still locks in bigger wins than the CFR strategy.

That’s my take,

 

 

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