If you’ve ever felt bad about a poor stock decision, just think of Bill Ackman, the famous hedge fund investor and activist, and his recent decision to throw in the towel on Valeant Pharmaceuticals.

It shows it can happen to the best of ‘em.

It also shows the value of using sell stops when you own stocks. If there’s a lesson to be learned from Ackman’s doomed Valeant trade, that’s the one to focus on.

The Road to Disaster

Valeant was a high-flying biopharmaceutical stock in 2015. Questions about its accounting practices and drug-pricing strategy cracked the shares from a high of $257 a share to $100.

And in swooped Ackman. His firm, Pershing Square Capital Management, purchased tens of millions of shares. The stock, he believed, would hit $450 by 2019.

At the outset, it looked like a typically successful Ackman play…

  • He had a convincingly thick deck of PowerPoint slides explaining why other investors were wrong.
  • His purchases netted him two seats on Valeant’s board of directors. The company had to do his bidding after that.
  • Ackman had been down this road before. He’d used similar boardroom tactics over the years to pry corporate changes — and higher stock prices — out of the likes of J.C. Penney, Kraft Foods, Fortune Brands and other companies.

But it didn’t work with Valeant. Other investors were unconvinced ­— and kept selling.

This week, with his Valeant shares down 90% from his purchase price, Ackman swallowed hard and sold off the stock. Bloomberg estimates his loss at $2.8 billion or more.

And therein lies the problem. Ackman had been right about stocks so many times, he convinced himself there was no way he could possibly be mistaken. And he paid for it big time.

How could he have avoided that trap?

By using a sell stop.

I don’t mean putting a standing order underneath the stock price, just waiting to get triggered. It doesn’t work that way when you own millions of shares, of course.

But most successful traders, such as my colleague Paul, already have a price in mind before they buy a stock. It’s their “give up” price, the point where they decide to bite the bullet and get out for a small loss — usually around 20% or 25% below their purchase price…

Before their trade becomes a Valeant-sized loss of 50%, 70%, or more.

Kind regards,

Jeff L. Yastine
Editorial Director

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