The Art of Execution

Book By Lee Freeman-Shor

Article & Review by GlobalMacroForex

As manager of mutual fund managers, Lee Freeman-Shor has unique insights into risk management.  He analyzed 1,866 investments made by 45 professional investors and found only 49% of investments made money and even many of the most legendary investors were only successful 30% of the time.  Therefore the difference between the overall winners and losers is risk management.

In this book, Lee Freeman-Shor’s primary thesis is to have a stop loss in the range of 20% to 33%.  Since he considers less than that not allowing enough risk, but more than that is eating into profits.  He says the key is to let your winners keep running but cut your losers short.

“Winning is about ensuring the upside return potential is significantly greater than the downside potential loss”

According to Lee, the primary reason that losing investors refuse to cut their losers short is that they don’t want to acknowledge failure.  They likely fall in love with the investment idea (called the ‘intimacy effect’) as well as refuse to change the investment idea based on new information (called ‘the anchor effect’).  Lee’s main book premise is that by having a clearly predefined stop loss and fully acting on it, you can remove these clingy biases and the unwillingness to let go of losing positions.

Losing positions quickly eat into your capital and make it even harder to bounce back.  This is because once you lose money; you need an even higher percentage gain upwards to break even.  Lee demonstrates this with this chart:

On top of that, time is money and you’re wasting capital on a position that isn’t helping you.  Even if you want to buy more of the equity now that it’s cheaper, he says it’s still important to have a stop loss.  Once you’ve sold your position, you’re less emotionally invested in the decision.  You can always rebuy it.

According to Lee, when a stock goes down 20%, you should never sit there doing nothing.  You should either:

Option 1)  Get out of the position and acknowledge the failure

Option 2)  Or buy even more of the stock now that it’s a value

Equally important to avoiding large capital losses is to let your winners keep producing profits.  According to Lee, we frequently sell stocks too soon because we want the rewarding gratification of taking profits. 

I highly recommend this book to give you a blueprint for your risk management strategy and to avoid the common pitfalls investors make.