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Editor's note: Today's essay comes from our good friend Peter Churchouse. Peter has lived in Hong Kong since 1980. He ran Morgan Stanley's Asia research department. And he has been an active investor in Asian markets for decades.
Peter's my go-to analyst for Asian investments. Today, we're sharing a piece he recently sent to his Churchouse Letter readers. If you're invested in China – or any risky investments – you need to read this...

You Have to Follow Your "Discipline" in China

By Peter Churchouse, Founder, The Churchouse Letter
Monday, August 3, 2015

With a big correction taking place across Chinese and Hong Kong markets, a reader wrote in to tell us that he was approaching his trailing stop loss on Hong Kong's Hang Seng index tracker ETF [exchange-traded fund].
But, he pointed out, the market was now trading at a very attractive level in terms of valuation.
The question: shouldn't he just hang on with the trade?
Anyone who uses a trailing-stop discipline will encounter this situation at one point or another...
... and it's a good example of why I refer to trailing stop losses as a 'discipline'.
So let's break it down a little here...
The first thing to remember here is that our number one priority isn't making money.
That may sound strange coming from an investment newsletter, but it's true.
Our priority is not making losses.
Given that ANY investment involves risk, then our priority becomes minimizing losses.
It was Benjamin Franklin who said, "An ounce of prevention is worth a pound of cure."
The trailing stop loss is our 'ounce of prevention' against the kind of 50% or more loss that drags down your portfolio performance.
That's the kind of loss which then needs a 100% gain (i.e. a pound of cure) to get us back to even.
The reader rightly pointed out that at less than 12 times current year earnings, Hong Kong's Hang Seng index is pretty cheap.
But that's simply not relevant right now. Plus, it was cheap when we recommended it in the first place!
What IS relevant is that we hit our trailing stop.
By acting on our stop it means that we immediately eliminate any further potential downside.
When you hit a stop, the rule is act first, analyze later.
You see, just because we exit a trade, it doesn't mean we can't re-enter it again in the future.
Withdrawing from the position allows us to step back, reassess the market and the opportunity, revisit our thesis, and go from there.
The problem with 'hanging on' is that we are allowing a small loss to potentially become a big one.
I would much rather forgo some upside to protect against a lot of downside.
Give me the ounce of prevention any day...
Meanwhile, China's market had its biggest single day drop in eight years this week, falling by more than 8.5%.
And Hong Kong's Hang Seng Index fell by more than 3%.
Investors who tightened their trailing stops on our primary China recommendation (and carried them out!) have avoided this stomach-churning volatility.
But this kind of market bloodletting will provide us with fantastic opportunities to buy great companies at bargain prices... but that's for later.
We want to have some cash for when this market starts to bottom out.
In the meantime, please keep to your trailing stops and continue to bide your time on a broad re-entry into the China market... this ain't over yet.
Good investing,
Peter Churchouse

Further Reading:

"Now is NOT the time to own Chinese stocks," Steve writes. "But that doesn't mean I'm giving up on China for good... I do intend to get back into China at some point." Find out how Steve plans to profit from buying China again in the future right here.
While it's not time to own Chinese stocks, Steve says it's a fantastic moment to buy another asset – real estate. It's where he's putting his money right now. And he says you should, too. Get all the details here.

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