Don’t forget to use protection!

Friday, 16 August 2019
Adelaide, Australia
By Bernd Struben

  • Safety not guaranteed
  • Gold stocks to the front of the class

If you’ve ever been to Boulder Colorado, you’ll be familiar with the Flatirons.

Five of these monolithic rock formations rise from the edge of town into the Rocky Mountains beyond. Some stretch more than 300 metres from top to bottom.

There are hiking trails that wind around the back to take you near the summit of a few of them. But as you’d expect, the towering red slabs are also popular with rock climbers who go straight up the face.

I dabbled with rock climbing off and on when I lived in Colorado. I was never an expert, but some of my mates were. And so one summer day I found myself scaling the face of the Third Flatiron, following my friend’s lead.

The Flatirons are multi-pitch climbs. Meaning, they’re too big to set up a top or bottom rope. You need a lead climber — my mate — to go first. He placed various pieces of protection into crevasses and looped the rope through those as he went. (Even in the ‘90s, banging pitons into the rock face was verboten.)

When he’d get close to the end of our 50-metre rope, he’d find a spot to anchor himself into the cliff face. My job then was to remove the protection devices (they’re pricey) as I scrambled up after him. His job was to give me enough rope to freely manoeuvre, but not so much that if I slipped I’d pick up enough speed to take us both down.

For a five pitch climb you repeat the process five times.

It was during the third pitch, some 120 metres off the ground, that I fell. It was an unpleasant moment. I did manage to croak, ‘Falling!’ as my toes slipped from their tiny hold.

And then indeed I was falling. But only for three metres. Then the rope snapped taught around my harness. My friend flashed me a thumbs up. And we resumed our climb.

I was then, and remain today, profoundly thankful for that rope and the protection pieces in the rockface. But not everyone was using them.

Before we reached the summit a wiry, bearded free climber scrambled past us. He was barefoot and shirtless. And if he’d fallen he would have gone all the way to the trees waiting 200 metres below.

Now fortunately he didn’t fall. At least not on that day. But that day at the Flatirons is has always been a healthy reminder for me to use appropriate protection in risky endeavours.

In rock climbing that’s a sturdy rope with enough slack to give yourself room to move.

In investing that’s a stop loss you stick with.

More, after the markets.

Markets

Overnight, the Dow Jones Industrial Average closed up 99.97 points, or 0.39%.

The S&P 500 closed up 7.00 points, or 0.25%.

In Europe the Euro Stoxx 50 index finished down 5.92 points, or 0.18%. Meanwhile, the FTSE 100 lost 1.13%, and Germany’s DAX closed down 79.99 points, or 0.70%.

In Asian markets Japan’s Nikkei 225 is down 7.57 points, or 0.04%. China’s CSI 300 is up 0.90%.

In Australia, the S&P/ASX 200 is down a slender 0.91 points, or 0.01%.

West Texas Intermediate crude oil is US$54.92 per barrel. Brent crude is US$58.54 per barrel.

Turning to gold, the yellow metal is trading for US$1,524.99 (AU$2,246.60) per troy ounce. Silver is US$17.28 (AU$25.49) per troy ounce.

One bitcoin is worth US$10,257.49.

The Aussie dollar is worth 67.78 US cents.

How much slack do you need?

With the market scares we’ve had this week, a little risk management review seemed in order.

Yesterday, the Aussie share market endured its worst day in 18 months. By the time the dust cleared the ASX 200 was down 2.9% while the All Ords had shed 2.8%. All up $60 billion had evaporated. To put that into perspective, that works out to $2,400 for every man, woman and child in Australia.

Now obviously foreign investors lost money on the ASX too. But then Australians would have lost money on overseas exchanges as well.

Undoubtedly a lot of stop-losses were triggered yesterday. When that happens it can add to the selling frenzy and drive markets rapidly lower. But that doesn’t mean you shouldn’t have stop-losses in place.

As a quick review, a stop-loss does exactly what its name implies. It can stop you from losing money when the share price of one your stocks falls.

There are several stop loss methods you can use. Then you can set the order with your broker to be carried out automatically. Or, if you’re diligent, you can monitor the share prices of your stocks yourself and sell if any stop-losses are breached.

One effective method is to set the stop-loss at a certain percentage below your buy-in price. For blue chips that might be 10%. Meaning if the stock falls from $10 to $9 you sell. No questions asked. For more volatile stocks — think small-caps — you probably want a wider stop loss. Maybe 20%. Set it too tight and you risk getting ‘stopped out’ during an intraday move that could well correct before market closing.

Another useful method is the trailing stop-loss. In this case your selling point moves up as the share price increases, helping to lock in your gains.

Let’s say you use a 10% trailing stop. When you buy your stock for $10 per share the trailing stop is at $9, just as above. But in this case as the share price goes up, so too does your selling point. If the stock later trades for $15, your trailing stop is now $13.50. That’s 10% below the new price. And represent a gain of $3.50 per share if the stock tanks and your trailing stop is breached.

Now the risk of using this safety device is that the share price might bounce back after hitting your stop-loss level. That can happen. And it’s frustrating! But more often than not, the risk of the stock continuing lower outweighs any odds it will quickly bounce back.

But there’s another risk to highlight here. One that too many novice investors fail to fully grasp.

Stop-losses — like all safety devices — can fail.

Safety not guaranteed

No sane manufacturer of climbing ropes or harnesses would ever guarantee your safety clinging to the side of a cliff. The rope can break. The protection you’ve carefully wedged into the crevasses can pop out under the strain of your fall. Rock climbing is inherently risky to life and limb.

Just as investing in equities is inherently risky to your wealth. Which is why you choose your investments carefully. Something our editors and analysts are here to help you with.

And most of our advisory services have stop losses in place. But as I said, beware that they don’t always work as advertised.

Let’s look at an example from today, outdoor advertising company oOh!Media Ltd [ASX:OML].

As the AFR notes, oOh!Media:

‘[C]ut its profit forecasts, citing a “significant decline in overall media advertising spend” and “general economic uncertainty”. oOh! warned its 2019 financial year earnings will be about $27 million – or 17 per cent – less than it had earlier forecasted...’

Clearly not what the market wanted to hear. You can see the fallout in the intraday price chart below:



chart image
Source: Google Finance
Click to enlarge

oOh! closed yesterday at $4.04 per share.

By 10:15 this morning, 15 minutes after the market opened, the stock was trading for $2.32. That’s a loss of 42.6%.

Now if you had a 10% stop-loss in place, you were probably expecting to sell for $3.64. But the odds of finding a buyer at that price during the 15 minutes of freefall are slim to none.

Most likely your sell order wouldn’t have been filled until shortly after 10:15. You can see that’s when bargain hunters began snapping up shares.

Now none of this is intended to scare you our of the markets. There’s still big money to be made on the right stocks. But with volatility on the upswing, it pays to use protection. And to understand that sometimes that protection can fail.

Gold stocks to the front of the class

Before leaving off for the weekend, have a look at this chart:



chart image
Sources: Bloomberg / Capital Economics / AFR
Click to enlarge

These are the best and worst performers on the ASX 200 yesterday.

As you can see three of the top five stocks were…gold stocks. (Pilbara Minerals, in the bottom five is a lithium miner.)

If you’ve been following along these past few weeks that won’t come as a surprise. And if you’d like to get in on what could be four of the most profitable gold plays on the ASX there’s still time.

You can get all the details — including the risks — here.

Cheers,
Bernd