The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (January 28)

With the recent market volatility (both up and down), let's talk about sell stops. First, what are they? Stops are simply open orders you place with your broker instructing him to sell your stock if the price drops to a certain point.

But stops have their drawback. Here are some of the dangers of sell stops: 1) Not all brokers will accept them on over-the-counter stocks because of the differences between that market and the exchange system on the New York Stock Exchange. (This may be more an inconvenience than a danger, but it's something to ask your broker about when choosing where you want to open an account.)

2) A stop doesn't guarantee you'll get out at your price. Let's say a stock is trading at $50 a share and your stop price is in place at $49. But after the closing bell, the company announces that it's going to miss earnings by 30%, the CEO ran off with the pension fund, and Larry Bud Melman is being hired to run the company. When your stock opens the next day (if it opens at all), it's going to trade at about $15 a share if you're lucky. Your stop price becomes meaningless and your shares will be sold immediately at that $15 or so. A stop means your order is supposed to be executed the first time the stock trades at or below your price. It doesn't guarantee you the price you set.

3) The most common problem with sell stops is that you may get stopped out of a stock that's simply going through a quick correction, only to rebound even stronger than before. This is especially true with very tight sell stops (say 5% or 10% below the current stock price), but can even happen with looser stops on occasion.

With all that's potentially bad about stops, why use them at all? There are a few advantages, too, and most of them center around the desire to protect profits and prevent big losses. Some people simply need the added discipline of a pre-set loss limit. "By golly, I don't care if Uncle Jim is the president of Losers 'R Us, it's down 30%. No more!" Too often investors get so attached to a winning stock, they're hesitant to let it go when the time is right. I'm guilty of this; I bet most of you are as well. A sell-stop set loose enough to allow room for normal corrections can help protect you against giving back all the gains you worked so hard for in picking a winner in the first place.

A timely example can be seen in AMERICAN POWER CONVERSION <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APCC)") else Response.Write("(Nasdaq: APCC)") end if %>. Since I wrote not too long ago about holding American Power Conversion, I'll use this as an example. In July, the stock traded around $9 per share. Since that point, it soared nearly 250% to a recent closing high of $31 3/8. Mindful of my experience in 1995 with MICRON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %>, where I watched what had been a ten-bagger give up roughly two-thirds of its value, I placed a stop on American Power Conversion at 25% below its highest closing price, which means at $23 1/2.

That stop loss point was triggered this afternoon when the market dropped like a stone. Now whether that turns out to have been a good choice or not remains to be seen. ($23 1/2 was the stock's low today, incidentally. It closed 5/8 higher than my stop point.) Did I protect my gains or did I sell out at the bottom of a normal correction? I don't know and won't know for a while yet. But I've accepted that potential risk as part of my growth-stock investing approach because I can't bear to watch a great winner turn into a dud. I'd rather have exited too early and moved my money into another stock than stick with a winner while it turns into a loser.

I realize this borders a tad on heresy here in Fooldom, but there's room enough under this motley umbrella for a reasonable range of styles, I think. This particular "insurance policy" is one I feel comfortable with because of past experience with growth stocks going from the heavens to the dust. You must make your own strategies work for you. And part of the process of investing is learning from mistakes. Fool on!

For those of you playing the Thoroughbred Stock Challenge, the new entry form for February's game is up on the website and ready for your submissions. I will accept entries (based on the date and time-stamp provided by the server, so leave yourself some room for slow connections) up until the opening bell rings on Monday, February 3.

Monthly Growth Screens
     (Jan. 3 to present)
22.89%  Relative Strength  
17.96%  YPEG Potential  
  9.35%  Low Price/Sales  
  2.27%  S&P 500 Index  
  2.25%  Investing for Growth  
  0.18%  Unemotional Growth  
 -2.40%  EPS Plus RS  

Annual Value Screens
     (Jan. 1 to present)
  3.22%  Dow Jones Ind Avg  
  3.05%  Beating the S&P  
  2.94%  Dogs of the Dow  
  1.25%  Dow Combo  
  0.62%  Unemotional Value  
  0.62%  Beating the Dow  
 -1.18%  Foolish Four