This led me to play around a lot over the last six years with stop losses. A stop loss is a point at which you decide to sell a stock if it declines. There are lots of different theories on stop losses and where to set them. O'Neill set his at 7% below the price at which he bought a stock. He was very keen on buying a stock at what he considered to be just the right moment. Typically this was when a stock was breaking out of what he called a cup and handle chart pattern. A popular investment newsletter, the Oxford Club Communiqué (which I subscribed to for a year recently - I like to keep tabs on the competition - it is, I must say, an excellent newsletter) sets a trailing stop loss of 25%. A trailing stop is one that moves with the stock. So say a stock is at $100. A trailing stop of 25% would mean you tell your broker to sell the stock if it drops to $75. But with a trailing stop, as the stock goes up, so does the stop loss point. So when that stock hits $110, the 25% trailing stop becomes $82.50.

 

In my own case, I started with a trailing stop loss of 10%. Then I decided this caused too much trading in and out of a stock. So I changed it to a graduated scale - initially 10%, when a profit of 10% had been achieved, the trailing stop grew by one percent to 11%. Each ten percent rise would increase the trailing stop to a maximum of a 15% trailing stop when a 50% profit had been achieved. This guaranteed to lock in profits if the stock should head south. Then I changed it again to 10% below the purchase price or a trailing stop of 15%, whichever was higher. All this playing around with stops proved very unsatisfying as I found myself whipsawed out of stocks only to see them recover.

 

I remembered Warren Buffett's view that you should buy the stock based on the company's fundamentals and hold it, possibly forever.  But I also read a number of bearish analysts - mainly gold enthusiasts, and because I agreed with them on much of their politics and understood their position, having been a gold bug back in the 70s, there was still a part of me that was scared of the market, scared of a potential rout. It was like that pop song, torn between two lovers - the appeal of the argument that government malfeasance and economic mismanagement would wreak havoc with the economy, and the appeal of the simplicity and elegance of a Buffett buy and hold approach to the market.

 

This led to some experimentation and eventually to the method I use now, a hybrid approach I call the Rich Get Richer Method. Basically at each quarter end, I invest in the ten best performing stocks from my Watched List for the previous quarter. I hold them for a full quarter - no stops - let the chips fall where they may. Then as a new quarter passes, I swap out the stocks for the new Top Ten. Stocks that continued in the Top Ten for another quarter are held and so have a greater weighting. Last year I tested the idea out and created a Rich Get Richer Portfolio. By year's end, this portfolio had grown 16.16% compared to my Model Portfolio's paltry 4% and change. So at the beginning of the year I amalgamated the portfolios and also added a mutual fund component. This has proven very successful as my Model Portfolio with a Rich Get Richer component is up 18.69% so far this year, my best showing ever. And we haven't even got to the fourth quarter which has proven to be the best quarter for us year in and year out. It also saves me a lot of headaches as I don't worry about my stocks and don't really even have to look at them for a quarter.

 

In any event, that leads to this week's featured article.