Thursday, September 6, 2012

How Stop Loss Orders Make Money

By Al Thomas

First rule of successful trading: Knowing when to sell.

Any fool can buy. It is knowing when to exit the position either with a profit or a small loss that makes the difference at the end of the year..

Notice I said “end of the year”. During the year every trader (call them investors if you wish, but there really isn’t any difference). During the year the trader will have made several trades. If he didn’t he is not watching his money. You can’t leave it up to a broker.

Mutual funds make stock switches many times during a year. In a bull market they do well. In a bear market they are usually wrong- as is easily seen from their poor performance. Any fund that has lost more than 10% or you might want to go to 15% loss is not a place to have money invested. It is better under your mattress.

A very recent example of why a stop loss would have helped your portfolio is Netflix (NFLX). You might even subscribe to their TV service. If I owned the stock (and I don’t) I would have seen it plunge from a high of $300/share to now abut $115/share. Almost 2/3 of your money wiped out.

Let’s supposed you had been smart enough to have had a 10% open stop loss order trailing after this puppy. At 300 the stop would have been 270 and now your account would have $270 in it instead of $115 (multiply by the number of shares).

Big difference, huh?

It is not uncommon for shares to crash 50%. Ugh! Health Service (CSH) 16 to 8; Sonic (SONC) 12 to 6.5; Edward Life Science (EW) 92 to 62; and hundreds more if you want to look for them. That’s what bear markets do.

The smart investor can’t sit around with his finger up his nose waiting for them to come back. A 50% loss means it has to gain 100% to get back to even. If Mr. Smart Investor had taken a small 10% hit he would be money ahead. He could even consider the difference between the 50% loss and the 10% loss as a reverse profit. One loss he didn’t have to take. The money stayed in his portfolio.

ETFs (Exchange Traded Funds) and Mutual Funds are very similar in that they are composed of many different stocks. However there are many advantages to ETFs that I won’t go into now. The one big advantage is trailing open stop loss orders can be placed by the investor with the broker. You set the amount and he must execute..

There is no such thing as a good stock. Even the good ones have big breaks. Buy them back after they start up again.

Rule ONE: Protect your portfolio from major losses.

Stops are the easy way to do it.

Al Thomas’ new book, “If It Doesn’t Go Up, Don’t Buy It!”, 3rd edition, has helped thousands of people make money and keep their profits with his simple 2-step method. The method made 10% during 2008. Read the first chapter at http://www.mutualfundmagic.com and discover why he’s the man that Wall Street does not want you to know. Copyright 2010 Williamsburg Investment Co. All rights reserved.

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