If a stock has very strong support 2% below its current price and it declines, breaking through that support, it is not likely to rebound soon, if at all. The same thing is true if a stock has built a good "base," is bought on a subsequent breakout through overhead resistance with a large increase in volume, and then it breaks down enough to trigger the stop loss. It is unlikely that we will regret the sale later. The conditions are defined sharply enough for us to render an accurate assessment of where the stock should be sold. Thus, it is not necessary to set the stop loss at 15%. Even if the maximum loss permitted is 15%, the average loss would likely be a much lower number. If the average is 8%, the greater flexibility available through support and resistance analysis will yield much better investment results than would be possible if a person rigidly sold all stocks when they were at a loss of 8%. Support and resistance analysis should enable the investor to avoid many "whipsaws" that could not be avoided with a more rigid system. In many cases there would be a profit where a more rigid system would have sold at a loss.

Changing the number of positions your portfolio is designed to carry could be a means of modifying the foregoing. For example, a twenty position portfolio could allow a stock to drop 20% without it inflicting more than 1% worth of damage on the portfolio. However, allowing more than a 15% decline did not produce any further improvements. In our view, therefore, there is little reason for most investors to expand the number of portfolio positions to more than 15 stocks. What we have said is based on the premise that the investor does not want to allow any position to be capable of damaging the portfolio more than 1% in a worst case scenario. If the investor wants the potential damage due to a single stock to be limited to no more than .5%, then the portfolio should contain 30 stocks.

However, our research showed that allowing a 15% decline for the stop loss dramatically reduced the chances that the stock would turn around immediately after it is sold. This information can be a powerful tool that a long-term investor can use to shape his stop loss strategy for maximum effectiveness. It can be used to set the tolerance for the negative impact of any single stock on a portfolio at any level the investor desires. To keep that 15% drop from impacting the portfolio more than 1%, the position cannot represent more than one-fifteenth of the portfolio. From this perspective, then, a 15-position portfolio is optimum for a long-term investor.

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