Stops Make Money

During the day I watch CNBC-TV, the stock market channel. Fortunately, I keep the sound muted or I would be hollering at the dumb "experts" being interviewed. The experts seem to know all about the market except they don't know how to protect their capital.

Every few minutes there is a chart in bright yellow of some stock showing its price performance during the past year. Lately it seems that most of the stocks have lost from 50% to 80 or 90% of their value.

Oh yes, this beauty did go up from 20 to 120, but is now back to 20 or some number very close to erasing almost all of last years profits, many going to a loss. The commentators give a nice running explanation of the "reasons" this stock did what it did. All hindsight and we know hindsight is 20/20.

Not once have I heard one these mavens ever suggest that a trailing stop would have sold out the stockowner at a nice profit within 10 or 20% of the top of the move. Microsoft went to $120 and proceeded to lose 50% of its value, dropping to $60. If you had had a distant trailing stop you might have been sold out about $90 or better. If you are still in love with MSFT you may now buy many more shares than you had before. Make sense?

There is a correct way to use stops, but the best is a mechanical method. Just set an amount you are willing to give back. Some traders recommend an 8% stop, others 15% to 20% of the low of the previous week placed with your brokerage firm each Monday morning as a Good-Til-Cancelled sell order. There is also the simple close below the 20-day moving average computed weekly. And many others. If you care anything about your money you might want to do some study to see the type of stop you might wish to employ to protect your capital.

Most professional traders, and I know most people are not professional enough to do this, will place their sell stops below what they consider to be critical support. This is a matter of interpretation and requires experience. I can almost guarantee your broker doesn't know how to do this so you should adopt one of the mechanical methods. When your stock or mutual fund is making that loud swishing noise going down the porcelain container your broker always comes up with the sage advice, "You are in for the long term" or "The market always comes back". In your lifetime?

Take a look at some of the dogs you are carrying in your portfolio right now. Figure out what would have happened if you had put in a trailing stop. My experience of trading for more than 30years has shown that if you had been stopped out that within 60 days that stock will be trading lower than your sell price about 80% of the time.

The first rule of investing is to protect your capital. Use stops.

Al Thomas' book, "If It Doesn't Go Up, Don't Buy It!" has helped thousands of people make money and keep their profits with his simple 2-step method. 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 2005