Having the right exit strategy can help you make more money on every single trade. Volatility-based trailing stops stand head and shoulders above the alternatives.
Sure, I may be a bit biased. After all, I created our proprietary Volatility Quotient and the “VQ” trailing stops.
The data, however, is crystal clear and I think by the time you finish reading this article, you’ll agree with me and you won’t ever look back again.
In my mind, there are always three choices for when to exit an investment or trade:
- An educated guess.
- A fixed percentage trailing stop like a 25% trailing stop.
- A volatility-based trailing stop.
Those are the three choices for me because that’s the evolutionary sequence that I went through as an investor myself.
I started out guessing when to sell. Then I understood that 25% trailing stops routinely helped me limit my downside and, just as importantly, un-limit my upside. Then I invented the VQ trailing stops.
Now if it were just me, I wouldn’t expect you to pay much attention. But time and again, my extensive research has shown that nearly every investor, novice and seasoned alike, shares an evolutionary bias that makes it almost impossible to make good guesses, no matter how educated they may be.
I saw it with my early mentor and now partner, Dr. Steve Sjuggerud. He’s the one who first showed me the power of using 25% trailing stops.
The chart below shows the performance of the True Wealth portfolio going back to 2001. The portfolio performed very well over the past 15 years. The chart also shows, however, that an automatic exit using a 25% trailing stop would have improved performance and my VQ trailing stops improved performance even more.
Here’s the example of Bill Gates and his Cabot Oil and Gas (COG) stock. Gates made a small gain on his trade. He would have lost money by using a standard 25% trailing stop, but he would have more than doubled his money by using the TradeStops VQ trailing stop.
And Warren Buffett would have been taking too much risk by using a 25% trailing stop on CVS Health Corp (CVS). The VQ stop would have gotten him out at the exact right time based on the underlying volatility of CVS.
But what does this mean for you? How much of a difference can using the right trailing stop really make in your portfolio?
A huge difference! Potentially thousands of dollars of difference.
And now we have the definitive research to close the books on any lingering doubts you may still be entertaining about the power of this approach.
Here are the results of more than 20 years of back-testing – using a 25% trailing stop against the TradeStops VQ trailing stops.
With a flat 25% stop, 51% of the trades were winners and the winning trades outperformed the losing trades by 4-1. That’s good.
But the TradeStops VQ system is better… and not by just a little.
By using the volatility-based VQ trailing stops, the system posted greater than 53.5% winners and the winners outperformed the losers by almost 5-1. And incredibly, the average gain per trade was more than 50% greater than the gains from using a 25% trailing stop.
It’s not easy to make money in the stock market. It’s almost impossible if you use the wrong exit strategy.
Using the right volatility-based stops can make a difference in your portfolio. Over a long period of time, you have a much better opportunity to make more and risk less.
Richard Smith, PhD
CEO & Founder, TradeStops