Always Use Protection! Trailing Sell-Stops for Safe Investing

By: David Van Knapp
For most individuals, whether to sell a stock is the hardest decision in stock investing.

It sounds simple at first: "Sell your losers and let your winners run." Sure, obviously. But how do you know which stocks are your future long-term winners and losers? More to the point, how do you tell the difference--right now--between a stock that is only on a short-term losing streak as opposed to one which is destined to be a long term loser?

Clearly, it's easy to list your winners and losers as of right now. But that's not what this particular decision is about. This is about future events--unknowable by definition. Even if your stock is falling in price, you don't want prematurely to decide that you made a mistake buying it or that its prospects have reversed from bright to dim. It may not be a loser at all. It just may have hit a bad patch. Your original positive outlook on the company and its stock may be correct, and the optimum decision may be to give the stock more time to reach its profitable destination.

A stock in a short-term stall can become a long-term winner.

On the other hand, we all know Rule #1 of investing: Don't lose. So you can't wait forever to make your decision when a stock's price keeps falling.

Every Sensible Stock Investor wants to take a strategic--not whimsical--approach to making sell decisions. You want to contain losses and sidestep risks.

The trailing sell-stop order is a very effective tool for sticking to a strategic approach. Let's make sure we understand what this order is. Then we'll talk about how to use them.

A trailing sell-stop order--which is a standard type of order available from all brokerages--has these characteristics:

• It is a "sell" order with a condition attached. You select the condition and attach it. When the condition is satisfied, the order to sell is executed--whether you are at work, in the bathroom, on vacation, or wherever.

• The condition is the "stop" price. That is the price you pre-select to trigger the sell order. If the stock's price falls to or through that point, the sell order is executed. You pre-select the trigger price when you are thinking objectively and strategically, not in the heat of a fast-moving market situation.

• It is a "trailing" order. Over time, as the price of your stock moves up, you reset the trigger price a little higher--say once per week. That way, the stop price trails along behind the stock's actual price, protecting you on the downside while not limiting your upside.

• It is a "standing" order. That means it just sits there until (1) it is executed, (2) it expires (3) you change it, or (4) you remove it.

Of course if the stock's price is going down, you leave the existing stop price alone. The whole idea is that it is there to protect you against losses. It does not take long to review and reset all the stop prices in a small portfolio--maybe a minute per stock online.

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