The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (Feb. 11, 1997)

3COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %> collapsed. AMERICAN POWER CONVERSION <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APCC)") else Response.Write("(Nasdaq: APCC)") end if %> soared, then dropped, then bounced, then plunged again. APPLIED MAGNETICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> went into orbit and is now attempting a re-entry. There's no doubt the hot topic will once again be safety nets.

Should there be a sell-discipline with mechanical screens other than the simple calendar rotations? Should one cut and run at some point or wait it out if the fundamentals look good?

Let me say from the start today that this is still the question I struggle with most as an investor and researcher. I've found lots of promising ways to buy stocks, but determining when to say good-bye is much, much harder. To that end, I've experimented with some sell-stop tests here and there and plan to do more of them in the future. Let's look at some recent examples from the growth screens.

The most obvious example of late is 3Com. The stock has been cut in half over the last month, agony indeed for all shareholders of this very prominent stock. How well would sell stops have worked? The two methods we've talked about recently in the Workshop are placing a sell stop at a certain percentage below one's purchase price (say 20%) and then ignoring it. For those who bought COMS in January as part of an Unemotional Growth portfolio, this would have meant getting stopped out somewhere around $60 and change.

Another method is a trailing stop, where you choose a percentage below the stock's highest closing price (say 25% or so) and then move the stop up if the stock continues to make new highs. With 3Com, the highest close was $80 1/8, so again, such a stop would have kicked you out around $60 a share. Given that the stock is now in the $30s, sell stops would have saved investors a bundle -- in this case, anyway.

Let's look at another case, American Power Conversion. This stock soared to a high of $31 5/8, so a 25% trailing stop would have kicked one out a week or so ago when the stock dropped to $23 1/2. Using the 20% method below one's purchase price in the Relative Strength screen would have gotten you stopped out at $22 or so. Late last week, however, the stock immediately rebounded strongly off those lows, back to the upper $20s, making the stop look like an invitation to the Whipsaw Ball.

But today, the company worried investors about future revenue projections and the stock collapsed again, almost back down to the level where the stops were triggered in these two examples last week. So, the jury's still out on the efficacy of this one.

Another example has yet to come into play, but very well might if technology stocks continue to slump. Applied Magnetics peaked out at $58 a share after a phenomenal spurt. Is it done? Is it going to go up again? No one knows, of course, but looking at the experimental safety nets we've been discussing, here's what could happen. If the stock continues to fall, the trailing stop at 25% below the peak would kick in at $43 1/2, about $6 a share below where the stock is now.

If one bought the stock this month using one of the mechanical screens here, the 20% stop below the purchase price is also somewhere around $43 5/8. So this will give us something to watch in future days and weeks. Will Applied Magnetics trigger these hypothetical stops (or very real ones for some investors), or will it rebound and set new highs? If it is stoped out, where will it be in a month or a quarter? Let's follow these stocks in coming sessions to see how the various stops play out. It's not an exhaustive test, naturally, but watching some of the action in real time can teach us a lot about how much emotion we can justifiably eliminate from the process of adding a reasonable safety net.

In the meantime, I'm going to run some experiments with stop losses on a selection of stocks which have scored huge gains in recent years to see if any patterns emerge. Stay Foolish!

Monthly Growth Screens
     (Jan. 3 to present)
 16.89%  Relative Strength  
 14.84%  YPEG Potential  
  7.98%  Low Price/Sales  
  5.55%  S&P 500 Index  
  0.05%  Investing for Growth  
-10.08%  EPS Plus RS  
-11.25%  Unemotional Growth  

Annual Value Screens
     (Jan. 1 to present)
   6.36%  Dow Jones Ind Avg  
   5.46%  Dogs of the Dow  
   5.10%  Beating the S&P  
   2.01%  Dow Combo  
   1.03%  Unemotional Value  
   1.03%  Beating the Dow  
  -1.33%  Foolish Four