Hello reader, welcome to the latest issue of HX Weekly!

Each week we bring you a new edition of HX Weekly that includes three distinct sections.

In the first section, Thoughts on the Market, we'll offer insights into current economic and market news or timeless insights.

In the second section, HX Daily Redux, we'll revisit investing concepts, tactics, and more from past issues of HX Daily.

And in the third section, Market Wizard’s Wisdom, we’ll share thoughts, quotes, and theories from the greatest investing minds of all time.

Now, let's dive in!

Thoughts on the Market

Readers’ Questions

One of my favorite notes to write is answering readers’ questions. I don’t get to write them often enough.

They are my favorite because they force me to think outside of my own perspective.

After more than thirty years, we assume readers understand many ideas and concepts. I challenge myself not to assume them. Still, it is hard to step outside my own view and truly understand someone else’s perspective.

My biggest complaint is that we don’t get to do it often enough!

So, PLEASE, email us with more questions – ha ha!

Here are a couple of good ones recently…

“EA, just read your excellent article on multi-strategy pods. As retail traders, how can we manage risk like them, yet ride up momentum? This seems like what STP does...with RSI, but we don't cut a losing stock fast. Certainly not fun riding down.”

This was in response to the article that we ran last week. Here is that note.

My response is that it is EXACTLY what our Signal Trader Pro software does!

While our STP Trader and STP income products have more leeway, the software has a strict numerical stop loss.

That stop loss is based on “alpha” as opposed to absolute return. This means we care less about how far the stock is down in absolute terms. We care more about how far it is down versus the overall stock market.

This keeps us from getting whipsawed by stock market volatility.

This is a slightly different implementation of what the multi-strategy hedge funds are doing, but it is conceptually the same.

Our version produces a higher risk-adjusted net present value.

This means we make more money across the population of decisions, even after adjusting the returns for volatility.

We may see larger drawdowns and more volatility, but the increase in returns more than makes up for it.

Why don’t the multi-strategy funds do it like us then?

The reason is LEVERAGE!

Even though it might be more optimal, their structure can’t tolerate larger drawdowns.

The tradeoff for them is that they get the benefits of that leverage on the upside.

So, the reality is that those following our software strategy are seeing very similar returns to a well-run multi-strategy fund.

The most recent version of the model, launched a couple of years ago, has produced a little bit less than a +15% annualized return. WITHOUT leverage.

Those multi-strategy funds do it WITH leverage.

We like our model BETTER and it makes a lot more sense for our readers.

We have had many opportunities to bring our model and work at these funds.

Why don’t we?

Honestly, at this stage of our careers, we find it much more rewarding to share our model with you all. It allows us to have a high-quality lifestyle and spend time with our families. It is also a lot LESS stressful.

We also get to hang out with all of YOU!

“My grandpa asked me, ‘How about investing $5000 in Anthropic IPO?’”

Our answer is THAT IS A TERRIBLE IDEA!

Without a doubt, Anthropic is an impressive company. Their pace of revenue growth in the last few years has been historic.

We also think their product is great. It will most likely be one of the most popular in the coming years in AI.

Finally, and most importantly, we TRULY believe in the promise of AI.

Our problem is not the product, but the COMPANY.

You all know we don’t generally care much about valuation, but at some point, it does play a role.

A $1.5 TRILLION to $2 TRILLION valuation on Anthropic is that point.

More important than that, we don’t think the company is going to hit its numbers.

They are going public at a moment when they have seen peak revenue growth rates. Few of their fixed expenses have kicked in and shown up in their numbers.

Revenue growth is already decelerating. All those expenses kick in over the next few quarters.

The result is we think they miss their 2027 numbers within just a few quarters.

Even if they did NOT miss those numbers, we think the hype is so extreme that the stock is a terrible bet.

Look at this chart of AI chip company Cerebras Systems Inc. (CBRS) …

They manufacture proprietary AI chip sets that have incredible advantages in efficiency.

It is a real company with a great product. Since they went public earlier this year, they have beaten numbers.

That IPO happened on May 13 at $185 per share. The stock traded up to a high of $386 the next day.

Today the stock is at $115 per share, and the chart looks like DEATH.

Again, this is an awesome company and product that has been beating numbers.

We think this is what the future holds for shareholders of Anthropic.

STAY. AWAY.

Following this week’s questions, we thought we would share one we hear often: what about stop losses?

Readers want to know how we cut losers without getting whipsawed by normal market moves. The goal is simple—keep the wins, limit the damage on the losses.

HX Weekly Redux

A Discussion on Stop Losses

The one question that we get most often is about “stop losses.”

For those unfamiliar with the term, a "stop loss" is the idea that you automatically close out a position if you hit a certain amount of loss. Usually, this is the price at which you close it out.

On the surface, most (all?) of the great traders and investors out there are advocates of a stop loss. Managing your losses is crucial to your long-term success as an investor.

Speak to many investors, and you will hear stories about how stop losses have cost them much money over time.

The solution is to use a more sophisticated method. Very few successful investors employ a simple "price" stop loss.

Neither do we.

On the back of reader questions, we thought today we would walk you through the stop loss methodology for our products.

At HX RESEARCH, we have two products focused on trading – STP Trader and STP Income – and one focused on investing – HX Legacy.

Each of these takes a different approach to a stop loss.

In trading, we are focused on the price of the stock and technical analysis. We are looking for short-term gains and respect whether the stock market responds to our idea.

Let's imagine we are right about the fundamentals, but the stock is not acting accordingly. We are likely to get out and move on to another position. In trading, we are primarily focused on price and not fundamentals.

Our focus on the price, though, must be focused on what is going on with the stock and not the stock market.

What do we mean by this?

A stock can go down for two reasons. It can go down because of something happening with the company, or it could go down because of something happening with the overall stock market.

The first instance – something with the company – is the one that concerns us the most. When a stock goes down, and the overall stock market does not, something is wrong with that particular stock. This is what we want to avoid.

If a stock goes down with the market, there may or may not be something wrong with the stock, but almost always, a significant downturn in the stock market will bring all stocks down.

Think of it this way – a falling tide doesn’t mean the ship is sinking!

This is why, in our trading strategies, we utilize a method called an "alpha" stop loss.

“Alpha” in the finance world means the performance of a stock versus the stock market.

If the market is +5% and your stock is +25%, the stock has produced a positive alpha of +20%. This is great. It means you are doing much better than just owning the stock market. Picking that stock added value.

Conversely, if in that market (the +5% market), your stock is -10%, then you have produced a negative alpha of -15%. This is obviously bad.

For our trading strategies, we look to close out a position if it produces a negative alpha of at least -15% to -25%. This means it has decreased at least that amount against the overall stock market.

Why not just a single number?

The reason is that different stocks have different volatilities or the amount by which they move.

For a low-volatility stock, the number will be smaller. For a high-volatility stock, it will be higher.

Does this stop-loss work for our strategies? Absolutely!

After running our strategies at Empire Financial without a stop loss for the first few years, we developed this stop loss.

In year three, we went and looked and saw several more considerable losses that we thought could have been avoided with a better process.

We back-tested and came up with the method that we use today.

We found out that using this method would have improved our returns by +1% to +2% per year. That is not a huge number, but with the strategy churning out high single-digit or low double-digit returns, it counts.

More importantly, it kept us from taking on big losers.

Remember that our trading strategies have very high "hit rates ."This means they win much more often than they lose. Historically, they have produced positive returns almost 75% of the time.

The key is ensuring that when you do lose, you manage how much you lose and don’t let it be too big.

Stop losses and risk rules only work if you have the discipline to follow them.

That brings us to John Neff. His quotes on selling high, doing the work, and rolling with the hits show why process beats emotion. The same habits that protect you in a trade also build long-term results.

Market Wizard’s Wisdom

Vanguard Value Master: The Wisdom of John Neff

Every Friday at HX Research, we dedicate a section of HX Weekly to exploring the story and wisdom of legendary investors.

We decide on whom to write about in different ways. Often, it will be something we read recently, or it can be market news.

Recently, though, we have been going out and looking at the BIRTHDAYS of famous investors.

This has led us to write about several investors—whom we know of but did not know much about.

This brings us to this week’s subject – legendary value investor John Neff.

Neff is most well-known for building the value-focused Vanguard Windsor Fund. Over his 31-year career running Windsor, he compounded at a +13.7% annual return versus +10.6% over the same period.

Neff was born in Ohio on September 19, 1931. After graduating summa cum laude from the University of Toledo, he joined the investment firm Wellington Management Company.

Neff became well known in the 1970s and 1980s, when we saw the emergence of "star" mutual fund managers like Peter Lynch and Sir John Templeton. He was also known for his value investment style, which contrasted with many of the other star managers of his time.

Neff posted an admirable track record of consistency that stands out amongst his peers.

Here is some choice wisdom of his over the years…

"A lot of people can't bear to sell when a stock's price is going up. They're convinced that they've made a mistake if they don't hold out for the last dollar."

We often explain how the "sell high" part of the famous saying "buy low, sell high" is the hardest part of the equation.

When the greed kicks in, and you feel like you have figured it all out, it is hard to maintain the discipline of trading.

To "buy low," though, you need to position yourself to take advantage of opportunities. The "sell high" move is the key to this.

One last note on this—and this is maybe the hardest one—do not ever regret making a big profit!

Enjoy your wins and avoid your losses. That is the psychological key to sustainable success.

“Shortcuts usually grease the rails to disappointing outcomes.”

One of our key mottos is “Do the Work.”

Like anything else in life, the key to success is preparation. We are not advocates for doing work for work's sake, but studying and refining your process is necessary.

Think about the importance of your money and the amount of research you would do if you were buying a house or starting a new business.

Do the same amount – or even more – when investing your money.

“Buy on the cannons and sell on the trumpets.”

We think the "buy on the cannons" is the more powerful of the two.

We have had tremendous success during BEAR markets by putting our investors in a position to be able to buy during periods of maximum pessimism. Again, the "sell high" portion of the equation is necessary to put you in that position.

The biggest short-term returns in stock market history have ALL happened during these periods. Put yourself in a position to take advantage of them.

“Inflection points occur in the market, and around them, performance can suffer, but you have to stick to your guns.”

This is such an important statement.

Markets trend. That underlying trend should help define your investment process at the time.

The hardest part is that these trends eventually change, and it is not clearly obvious when these changes occur.

You need to have a process in place to deal with and adjust to these inflection points. These points can make or break your long-term investment success.

“But if you can’t roll with the hits, or you’re in too big a hurry, you might as well keep your money in the mattress.”

Adapting but having a short memory is a key to surviving in the stock market.

If you are unwilling to accept and learn from a loss while moving on, you will not ultimately be successful as an investor.

Losing is a guarantee in the stock market. Master losing, and you will set yourself up to win.

We hope that you’ve enjoyed this week’s issue of HX Weekly…

Do you have any thoughts, questions, or feedback? Tell us more in the comment section or at [email protected].