Knowing when to cut your losses

During November, I was in action on three occasions, making changes to holdings in my individual savings account (Isa).

First, I added to my holding of Quarto – the self-styled publisher of books of an “enduring nature”. I believe it to be considerably undervalued, not least because its recent acquisition of Frances Lincoln brings with it Wainwright’s Lakeland publications, plus a wide range of gardening, architecture and art titles.

Second, I decided to sell my Aviva shareholding in favour of a stake in international infrastructure stock Balfour Beatty. Aviva’s share price has been gyrating on the back of eurozone turbulence, which looks to be with us for some time, and investors are clearly unsure as to the insurer’s exposure.

Balfour, which has a market capitalisation of £1.5bn, provides more certainty – as well as a 6 per cent dividend yield, a single figure price/earning ratio and a growing order book thanks to the government’s wish to stimulate infrastructural projects. For example, the company has just been awarded, in a joint venture, a £110m contract for the Whitechapel Crossrail development. In the last annual report, when Balfour’s shares were significantly higher, the chairman wrote: “I am conscious that our share price has not reflected what we believe to be the underlying strength and value of the business in recent years.” He went on to claim: “We have the capability to become the global leader in infrastructure . . . I am confident we will make further progress during the year.”

Third, I have taken my profit on MS International shares. I bought at 115p two years ago, and sold them just short of £3. They are clearly having an excellent year, but appear cautious on the future. I see my good friend and fellow FT Money columnist, David Schwartz, has been buying shares – perhaps he bought mine!

I was also pleased to hear that the long drawn-out takeover saga at insurance broker THB has ended with an agreed cash bid of 80.5p. Although I am slightly disappointed with that figure, at least it vindicates my purchases of THB shares between 54p and 61p. This significant pay-out will create some very useful liquidity for me in a few weeks, and leave me well positioned to reinvest with prices drifting lower.

I shall choose my new investments carefully, though, as I believe the key to successful investing is avoiding losses. We all have investment successes but, too frequently, these can be cancelled out by our failures. I have had three horrors in the last five years: Dawson Holdings, HMV and, currently, Cable & Wireless Worldwide.

It is not so much my original misjudgment of which I am self-critical, more my failure to acknowledge the mistake and to take swift action. We delude ourselves that “surely they can’t go any lower” – only to see a further downward spiral. Fortunately, I have had many more successes to compensate but I could have done better.

My fundamental error was not to operate a “stop loss”. I should have sold on the first 20 per cent fall and taken the loss on the chin.

By adopting a conservative approach, I believe it will be possible to avoid the worst of the downside. I think a 10 per cent stop loss is too tight – 20 per cent makes more sense and allows a recovery from a short-term dip. I will only make an exception if there is an overall market slump.

John Lee is an active private investor, writing about his own investments. He may have a financial interest in any of the companies, securities and trading strategies mentioned.