Please enjoy my monologue Engineering the Fundamentals with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive.
In this episode of Trend Following Radio:
Valeant vs. Enron
The Deep State
Fixing the media
Trading off price
“You have to fight back with intelligence. You have to fight back with smarts. You have to fight back with a good strategy. You can’t just sit there and accept what the system gives you because the system is going to give you exactly what it wants to give you.” – Michael Covel
A host of high profile money managers learned that the hard way recently when their investments in Valeant Pharmaceuticals reversed course.
For example, the Sequoia fund returned four times as much money as the stock market from 1970 through July 2015. What’s more, they did it with less volatility and lower drawdowns.
But Sequoia Fund’s brilliant performance came to a halt in the last year because of a single investment in Valeant.
At the peak, Valeant made up more than 30% of Sequoia’s portfolio. When Valeant began losing altitude, Sequoia’s managers failed to consider an exit plan. Instead of pulling the ripcord and exiting their positions, they added 1.5 million shares at the end of 2015 – only to see the stock nose dive a further 70%.
Trust the process
The lesson here is clear. You won’t always be right, and you must have a process in place for the inevitable times when you will be wrong.
A rules-based investment process like trend following establishes predefined exit points before entering each position. This process defines exactly how much capital is at risk with each position across the portfolio. That allows you to cut losing trades quickly – before they ever have the opportunity to grow into career-ending losses.
Here’s how a simple trend-following strategy could have worked on Valeant:
Using a 200-day moving average would have gotten you into the stock during much of its move higher through 2013 and 2014. Then you would have gotten out of the stock above $200 per share – before it lost nearly 90% of its value.
With this kind of strategy, you will give up some profits when stocks fail to trend higher, like in 2014. But giving up this relatively small upside allows you to systematically avoid disastrous losses.
A listener passed this along. An interesting post from Finance Trends (source):
Valeant Pharmaceuticals (VRX) is now big headline news, as the stock’s downward slide continues to punish investors, big and small.
Hedge fund manager, Bill Ackman of Pershing Square was reported to have lost $1 billion in a single day due to VRX’s latest plunge. Institutional ownership of Valeant’s stock was very widespread. As mentioned in our last post, a huge number of hedge funds and mutual funds owned big positions in VRX. Smaller investors may also be feeling the hit in their personal investment accounts or in their pension funds’ returns.
Let’s not focus too much on the investors who were unfortunate enough to get burned in this stock crash. The media and the investing world are already having a field day with this debacle. Instead, let’s take a fresh look at the chart to better understand why so many savvy investors were hurt in this decline.
As you can see in this updated daily chart (see below), VRX had been showing signs of distribution (professional selling) for weeks heading into the fall of 2015.
After breaking down through its 200 day moving average (the red line), the stock moved sideways for a time before plunging through the $150 level. Here’s where the decline really accelerated and volume ramped up.
Towards the end of 2015, we saw a nice rebound in VRX and a bit of chatter about how “everything would be fine” and “here is a smart place for big investors to average down and buy more”, etc. Well, as recent events have shown us, that is not exactly how things played out for the investors who stubbornly held on to their bullish “thesis” for VRX.
At the start of this week, VRX was trading near $68. By Tuesday, the stock had plunged by over 50% to close at $33.49. As of today’s close, VRX is trading at $29.65, 60% lower from our previous Valeant (VRX) update at the end of February.
If you didn’t read my last post on VRX, go back and check out the closing section, “How to avoid disastrous stock declines”. If you know someone who is stubbornly holding on to major losses in their portfolio or trading account, share the article with them. While nothing is foolproof in investing, these simple ideas may help you pare or avoid the disastrous losses that can ruin any investor, big or small.
“The most important rule of trading is to play great defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be. If they are going against me, then I have a game plan for getting out.” – Paul Tudor Jones, via Darvas Trader.