This Exit Strategy Will Save Your Sorry Hide From Losers

Sean Brodrick By Sean Brodrick,

Metals

There is an old saying about gold mining, one muttered by men nursing bitter losses: “A gold mine is a hole in the ground with a liar on top of it.”

That quote is attributed to Mark Twain, real name Samuel Clemens. But Clemens didn’t say it or write it. He did say something else: “I am not one of those who in expressing opinions confine themselves to facts.” That phrase makes me think Clemens missed his calling… He should have been a mine promoter.

I don’t think most gold mine promoters lie knowingly. But they are dyed-in-the-wool optimists. As are geologists, mining engineers and anyone out turning over rocks to find something shiny. They have to be.

Only an optimist would get out of his bunk every day for 10 years, determined to turn a patch of scrub grass and rocks into a working mine.

This is why boots-on-the-ground research is so important. You can’t go out and visit every mine, oil well or other investment… but when you can see one, it certainly doesn’t hurt. It helps separate the dreamers from the can-doers. It helps you narrow the list of stocks you want to buy and reject those that may have nice stories but not as much potential.

When Things Go Wrong

So let’s say you find a project with potential and you invest in it. You get it cheap! If everything goes right, you’ll look like a genius. But what if things go wrong? And the further a project is from production, the longer the list of things that can go wrong.

And once the mine is producing, guess what? Things can go wrong then, too!

So how do you position yourself to enjoy the tremendous upside if things go right… while at the same time avoiding financial ruin if things go not just wrong but terribly wrong?

One way is through position sizing. You want to keep each position small. That way, if things go awry, it’s just a bump in the road, not a catastrophe.

It’s also very important to use protective stops.

A protective stop is a predetermined point where you will sell a stock, fund or other investment. It can be hard or flexible. It can be based on a certain percentage, technical indicators, or price and volume indicators. It can be intraday or end of day.

If used properly, protective stops can be effective. It’s simple, really. They limit risk.

Changing Views

My view of protective stops has evolved over time. For one thing, we have to take into account the high-speed algorithms and robo-traders that make up an inordinate amount of the market volume now. Those programs exist to profit by shaving off a few cents here or there. They will purposely drive stocks toward obvious stops, trying to trigger them. That in turn will trigger investors to “sell” the position, so the robo-traders can buy it on the cheap. They then hold the stock for a bounce.

The relation of the swing in the stock to fundamentals? None!

In my opinion, robo-traders have made intraday stops useless. I won’t use intraday stops anymore. You really need to use end-of-day (or “close-only”) stops.

That’s one reason why the publisher of Energy & Resources Digest, The Oxford Club, recommends placing a close-only sell stop 25% below the entry price of a position. As the stock rises, the stop rises with it.

But depending on the market and the size of the stock, different stops are in order.

Wider Stops for Smaller Stocks

For example, in my Gold & Resource Profit Hunter, we use a trailing, close-only 35% protective stop. That’s because that service often invests in small cap and microcap mining companies that are easy to push around. They can drift lower on a lack of news… then take off like rockets once good news hits.

On the other hand, junior miners are just the kind of stocks where things can go very wrong.

Let’s use Rubicon Minerals (OTC: RBYCF) as an example. In April of last year, the company said it was on track to begin gold production at its Phoenix mine in northern Ontario by mid-2015. It poured its first gold in June of that year.

But at the same time, the company ramped up spending. In October, the CEO departed. And then the company halted all underground work and announced that the geology of the deposit was more complex than previously thought.

At its peak in 2010 (the last gold bull market), Rubicon was worth more than C$6.00 per share. In April 2015, after a long and brutal bear market in gold, Rubicon was still trading above C$1.20. After all, it was on the cusp of having a producing mine.

Then the bad news hit. More recently, Rubicon closed at C$0.045 per share. Ouch.

If you were along for that ride, a protective stop would have saved you. You might have taken a loss, but you would have exited in time to preserve capital.

Protect Yourself Against Yourself

It is very hard to sell a losing position. People who own a stock tend to believe in that stock strongly, even when the facts turn against them.

Let me give you another quote, this one from famed economist John Kenneth Galbraith: “This is a world inhabited not by people who have to be persuaded to believe, but by people who want an excuse to believe.”

One of the things you have to protect against in this market is the power of your own belief. It can blindside you. That’s why you need to use protective stops. They prevent a losing trade from turning into a crippling trade.

Because being stopped out isn’t the end. Capital you recover can always be put to work in an investment that will make more money.

Good investing,

Sean