The
Dow Approach
The
Dow Approach
| Dow Dividend Strategy | What's Here | The Statistics Center | Spin-Off Help | The Archives | |||||||||||||||||||||||
FOOL GLOBAL WIRE (March 18, 1997) -- Today I'd like to take a closer look at stops, limits, and how to know when to sell a stock. One of the largest problems facing new investors -- or even seasoned investors -- is knowing when to cut your losses or take your profits. Stops and limits were designed with just this purpose in mind. A stop or limit can be set at a desired goal for taking profits as well as limiting losses. Here's how they work: Stop Orders tell the specialist or market maker (depending on the way you trade, through an exchange or OTC) to activate the sell order as a market order when a specified price is reached or passed. This guarantees execution, but not price. In other words, if you put a stop on 100 shares at $40, when the stock reaches or passes $40, the order becomes a market order and is executed at the next best price available. Limit Orders tell the specialist or market maker (same conditions as above) only to sell when a specific price is reached or better. In other words, if you put a limit order to sell 100 shares at $40, when the stock reaches $40, and it must hit it exactly or better, it will trigger an execution. This guarantees price, but not execution, as the price must be met exactly or better. Stop-Limit Orders are a combination of the two. When you enter a stop-limit order, first the stop conditions have to be met, and then the trade becomes a limit order. When the exact price is met, the execution takes place. This helps to guarantee both price and execution. When you purchase a stock -- hopefully because research proved the company to be a growing, viable company -- it is often beneficial to decide how much loss you're willing to accept. From there, set yourself one of the limitation orders above, usually a stop order to guarantee that you get out when the stock drops. To do this, just decide what percentage you're willing to lose, calculate where the price would be when that limit is met, and set the order there. This is the unemotional way to guarantee that you don't lose more than your finances, or your emotional well-being, can handle. So, what's the downside? (And we all know there's always a downside.) Well, there's always the chance that the bottom has been reached and the stock could rebound. That's where you need to decide if you want to play or not. That's where the unemotional aspect of stops and limits comes in. But don't become so unemotional that you forget you set it. Sometimes news events can alter your perspective as to how far you're willing to allow the stock to drop. Sound complicated? Wait, it gets better. You can also set stops or limits to lock in your gains. To do that, you need to decide what price would be an acceptable gain and set an order to sell at that price. How do you do that? During your research you probably ran either a PEG or a YPEG on the company, which gave you a target price. Decide if you think the stock could sustain further growth and whether you're willing to wait on that further growth. From there, calculate where the price you'd like to sell would be. Set your stop or limit and relax. But don't forget that you set it, since any news that would alter the fundamentals of the company may also alter your price target. The downside? There's always the chance that the PEG or YPEG isn't 100% accurate, or that the market won't back the stock to that price. You need to take a close look at both the company and the sector it's in and see how the market is treating these stocks. Don't set your sites in outrageous territory, since you'll just be setting yourself up for disappointment. When you've reached a realistic goal, stick to it. The biggest downside to this type of unemotional selling is the stock possibly growing further than you anticipated. You need to decide if you want to take the risk of losing the gains you already have or just accept the gains as reasonable and satisfactory. Now, how does this pertain to the Fool 4 portfolio? Well, it doesn't. Since we buy on a specific date, hold for one year, and reevaluate after that year has passed, the guesswork is taken out of the buying and selling. But keep this in mind for any other buying and selling you may do. The less emotional you are, the better able you are to ensure that you don't take more losses than you can handle and that you lock in profits before they disappear.
Could this be the reason we call the Dow 4 the simplest way to invest safely?
Yep. Investing is fun, but it can dangerous. For me, taking the danger out
of it with an approach like the Dow 4 lets me sleep at night. How about
you? (c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. |
|
||||||||||||||||||||||
|
|||||||||||||||||||||||
|
