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How I aim to beat the FTSE 100 in 2018

There could be volatility ahead during 2018. Growth shares were in vogue during 2017, but any misses on expectations led to brutal knockbacks for several prominent names.  Maybe the bull market for growth shares is becoming fragile.

The long-term investor’s weakness

Back in September super-successful US trader Mark Minervini tweeted: “The time has come to change to a late-stage strategy; nail down profits into strength and temper your profit objectives.”

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Minervini is worried about reversals – the Achilles heel of the long-term investor. I am, too, and even British long-term investing legend Lord Lee owned up a few years ago to modifying his long-standing investing strategy to include the use of stop-losses.

Maybe we investors haven’t focused enough on the question of when to sell an investment. After all, it is well known that most private investors underperform the market, or worse, lose money. So for 2018, I aim to outperform the FTSE 100 by watching the downside closer than ever.

The arithmetical body blow of losses

Warren Buffett famously said “Don’t lose money” and with good reason: a 50% loss on a stock requires a 100% gain to break even again. You have to work twice as hard to make it back as you did to lose it.

But it gets worse than that. Minervini illustrates the point well in his book Trade Like a Stock Market Wizard with a handy table reproduced here:

Loss

Gain needed to break even

5%

                                     5.26%

10%

                                        11%

20%

                                        25%

30%

                                        43%

40%

                                        67%

50%

                                      100%

60%

                                      150%

70%

                                      233%

80%

                                      400%

90%

                                      900%

Small percentage increases in the amount we lose generate large percentage increases in the amounts we need to gain to get back to breakeven. If you lose 90% on a stock — as many did in 2008/9 on banks, housebuilders and others — it could take an entire investing career to invest what you have left back to break even. No wonder traders say “your first loss is your best loss.” The smaller setbacks are the easiest to recover from.

In the earlier days of his trading career, Minervini had a record of gains and losses that compounded to an overall loss of 12.05%. He then adjusted the results as if every loss he’d taken had been capped at 10%. If he’d capped his losses, that 12.05% overall loss would have been a 79.89% gain. That realisation changed his approach to trading and propelled him to a multi-million-dollar trading fortune.

Minervini quotes billionaire businessman Sam Zell: “The definition of a great investor is someone who starts by understanding the downside.”

The private investor’s special advantage

Yet one school of thought is to average down and buy more of an investment if it goes against us in line with the approach of investing with a business owner’s mindset. However, I think that ignores the private investor’s special advantage of liquidity that comes from managing smaller sums of money than large investing institutions. We can be nimble and, to me, it’s pragmatic to stick with a firm with an owner mindset in spirit, while tactically selling if the shares move against us to maybe buy back later. The preservation of capital could more than offset additional trading costs.

If stocks don’t go up after we’ve bought them, or at least remain stable and pay us a dividend income, what’s the point in holding them?

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.