We recently sold Company A (name withheld due to regulations) after 40% drop from the all-time highs. We got queries asking if we could have timed it better

Let’s break down the transaction in terms of how it played out rather than ‘anchoring’ to the all-time high

We invested close to 4% of the portfolio in several tranches. The exact price will vary for you based on when the transaction was executed. On average, the loss would be between 15-25% for most subscribers. This translates into a portfolio loss of 0.6% to 1%. Even in the extreme case of someone buying at the top, this amounts to 1.5% loss at the portfolio level

This is within the bounds of our risk management for individual positions. We try to keep our max loss between 20-25% of buy price and total risk at portfolio level at around 1-1.5% on cost basis. Based on historical data, this gives us a 3:1 to risk reward ratio and with a 55-60% win rate, our returns over the long run are above average

Hopefully the above live example shows how we think mathematically about individual positions and that Company A played out within our set parameters

Managing risk from all time high

We do not manage risk from all-time high for any stock

Doing so is valid for swing trades with shorter time horizons. We have done this partially with our position trades in the MA accounts, but Company A was not such a position

For our time horizon, selling a stock when it drops from all-time high, will result in jumping in and out of positions, especially in choppy markets such as now.

Trying to manage this type of risk brings up the following questions

• At what level should one exit? 20%, 30%?
• Do we re-enter if the stock drops 20% and resumes the journey upwards?
• Is there a fundamental criterion to exit? Keep in mind prices react before the fundamentals
• How about bear markets versus bull markets? In bear markets, a small miss can cause the stock to drop more than 20%

It is always easy to look at the stock price in hindsight and ‘know’ the right decision

Risk is managed probabilistically

The answer to the above questions is that ‘it depends’ and there is no perfect answer.

We aim to lose less when we are wrong but gain more when we are right. If we do this consistently over the long run, our portfolio returns will be good (as they have been for the last 15 years)

We will continue to exit positions which have not worked out, and it will be painful during bear markets. Exiting a position, even at a loss, does not mean we will not revisit it. We have made this mistake in the past and missed a 50 bagger

PS: There is a lot of nuance on this topic. We plan to publish a video post on it soon to explore it further