Stop Loss Order Methods
Author: Al Thomas
We have established why a stop loss order is a requirement for the successful investor. Now let's look at some of the simpler methods.
There are 3 basic methods (and many more we will not discuss here) for stops that almost anyone can master. They are percentages of the price action, moving averages and support areas. These cannot be covered in detail here, but you can do further research on your own.
Any stock, fund or Exchange Traded Fund (ETF) you buy you think is going to go up, but there is the chance that it may go in the other direction. The stock you buy is $50 per share. You certainly don't want to hold it while it goes to $25 or $10 as many did in 2000. Your first thought should be how much am I willing to risk if I am wrong and that is called your loss limit. Let's pick an arbitrary amount of $5.00 per share. That's 10%. If it goes down that is the maximum amount you will lose and you still have 90% of your money remaining to find a better investment. When it goes up you will want to protect your profit by moving the stop up.
When an equity advances to $55.00 your stop of 10% should be moved to $49.50 that is 10% 0f $55. When it goes to $60 your stop is now $54. Nothing complicated here. There have been many stocks that gone from $20 to $250 and then down to $2.00. Think what a stop loss would have done for you in that case.
As I have said before never buy anything unless it is going up. That same $50 stock was moving steadily higher in a rather narrow trading range. If you decide to use a 20 day moving average you will have to do the calculations either daily or weekly. You add up the closing prices for the past 20 days and divide by 20. This should be done once each week and the number calculated is your stop loss. Again nothing complicated. The steeper the advance the shorter should be the number of days for the moving average. If you are lucky enough to have one of those skyrockets you might even be down to a 5DMA. Some traders use a 50 day MA and others even a 200-day MA. Mutual funds lend themselves to the latter,
Finding support and resistance points requires a more sophisticated approach. This is something you are going to have to study. There are many places on the Internet that have short explanations with examples of how to determine these points.
Briefly you watch a stock, fund, ETF run up and then you see it stop and set back like a stair step. It will rest for a while with a short up and down sideways pattern that forms before the next move higher. Your stop should now be down at the point the recent up move started. When it advances again this current formation becomes the stop loss point. This is not mechanical and requires a more experienced trader to determine these points. Once you learn this technique you will also begin to see the orderliness of the market.
The mastery of an exit strategy with stop loss orders will immediate put you in the top 10% of all investors. Learning how to sell is the key to successful investing.
About the author
F*R*E*E investment letter www.mutualfundmagic.com
Author of best seller "IF IT DOESN'T GO UP, DON'T BUY IT!"
Never lose money in the market.
Copyright 2004 Albert W. Thomas All rights reserved.
Former 17-year exchange member, floor trader and brokerage company owner.
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