Chris Dillow replies:
I wholly agree that calculating past risk-adjusted returns is tricky, simply because there are so many risks that are hard to measure.
The question of whether stop-losses can reduce risk is fraught. A big problem is that shares can sometimes crash through the stop-loss price before you have a chance to sell. I'd justify their use not so much as a way of managing risk but as a way of managing our minds. It's easy to hold on to a losing stock in the hope of getting even, only to see the stock stay low, or fall further insofar as there are momentum effects; this 'disposition effect' is widespread and costly. Stop-loss limits are a cure for this.
John Hughman adds:
To add to Chris's point, we have flirted with the idea of introducing set stop-losses on our weekly tips, but decided against it on the basis that choosing a figure of, say, 20 per cent would be somewhat arbitrary given a) the different risk profile of each investment and b) the different risk appetites of our readers. Nor would a 20 per cent stop loss necessarily limit your losses to that if, for example, a price gapped down on a major profit warning. However, chiming with Chris's point about using stop-losses to "manage our minds" we do aim to update tips if the price moves 20 per cent in either direction. Of course, arbitrary stop-losses could work in our favour when totting up the aggregate performance of our tips over the year, but as we are a source of ideas rather than advice that would be little more than a rather self-serving marketing exercise. Better, we say, to admit our mistakes and learn from them. And while we suggest a risk rating for our tips, we do not do so for portfolios - in the case of stock screens, they are also an ideas generation technique, while Simon's Bargain Shares portfolio picks are all carefully assessed on a risk-reward basis. In the case of reader portfolios, our suggestions are based on the risk profile provided to us by the readers themselves.
