How to calculate your trailing stop loss correctly

Stop-Loss

This article is a website version of our weekly FREE Best Ideas Newsletter sent on 28.03.2023. Sign up here to get it in your inbox every Tuesday.

As I was planning this week’s purchases, I kept thinking, what if I buy now and the markets drop suddenly? Do you also think this?

There are so many things that can go wrong (think bank failures) but then again, a lot can go right.

For example:

The Chinese economy recovering strongly after the COVID lockdowns
Increased capital investment because of the greening of the economy incl. subsidies
Continued strong consumer spending because of inflation adjustments in salaries

The thing is, we just don't know what's going to happen, no one does.

The world is a complex system with 7 billion people making decisions every day. How can you, I, or anyone else possibly know what's going to happen?

I'm not buying overvalue junk

The other thing that made buying easier, is I'm not buying startups with no profit in sight or crypto.

All the companies on my list are mainly from the newsletter. All have very low debt, are undervalued, and have a stock price that is moving up (positive momentum). I am not buying a falling knife.

For example, a company the newsletter recommended nearly a year ago. The company still on most of the screens that I run, is nicely undervalued, and pays a dividend of just under 10%. It also has growth potential as its store count is still small. I'm tempted but am not going to give you the name because this would not be fair to newsletter subscribers.

I'm also thinking of increasing a few positions in tobacco companies as they've declined a lot for no reason related to the earnings.

In spite of oil and gas prices falling I'm still quite positive on the sector because of Chinese demand increasing, the USA still has to replenish its strategic energy reserves. Also, Europe still has to replace its gas reserves before the next winter. And one of the big utilities in Germany warned Europe is not out of the woods yet in terms of the next winter if it gets really cold.

That said I haven't quite made-up my mind as I got stopped out of a few positions specifically in gas companies. I'm still holding my oil ETFs which haven't come close to their stop loss levels yet.

Remember to include dividends in your stop loss calculation

This week when I looked at my portfolio two companies were close to their trailing stop loss levels. But when I looked closely this was not so.

So, I want to remind you to include dividends when you look at your stop loss levels. Especially companies with a high dividend yield.

As you know when a company goes ex dividend (trades without the dividend) its stock price usually drops by the amount of the dividend. For example, you own a company trading at $1.00 and it pays a 10% or $0.10 dividend it means the stock price will drop by 10%.

This means if the company was already sitting at a 10% trailing stop loss, and it falls another 10% it may hit your 20% trailing stop loss level.

But this is not right because the dividend usually gets paid a month or so after the ex-dividend date. This means that you must include the dividend (still to be received) when calculating the stop loss level.

Here's the formula: (Current stock price - the highest stock price + the dividend per share) / the highest stock price. In other words, you add the dividend still to be paid back to the decline of the stock price from its all-time high.

Your analyst wishing you profitable investing

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