With the Dow finally
topping the 10,000 markyesterday for the first time in a
year, lots of bullish investors are hoping that the party's
just getting started. If you're more concerned that
shareholders are
getting too greedyfor their own good, however, you're
probably thinking more about protecting the gains you've
already made than trying to eke out more profits from the
rally.
Nothing is more painful than seeing all your paper gains
on a stock position evaporate when a market downturn comes
around. To avoid having to go through that experience,
there's a strategy that many investors use to try to sell
their shares before a small correction grows into a drop that
could take a big bite out of your profits.
Stopping your losses
Stop-loss
ordersoffer a simple way to protect gains on a profitable
position. All you have to do is figure out how much you're
willing to see a particular stock drop before you'd conclude
that the rally was over. If you then entered a stop-loss
order at that price, your shares would be automatically sold
if the stock ever traded at or below the price you
picked.
You might wonder why you'd want to sell at a lower price
if you didn't want to sell at the higher price. The goal of
the stop-loss order, though, is to capture as much of a
long-term uptrend as you can. If you simply sell your shares,
you lock in a sure profit -- but you miss out on any future
gains. A stop-loss order, however, lets you make more money
in a rising market; if the stock keeps going up, your
stop-loss will never get triggered, and you'll add to your
gains.
In fact, many
brokersallow you to set trailing stop-losses. These
special orders automatically boost your stop-loss price as
the stock rises, saving you from having to change the order
manually.
Mixed results?
When stop-loss orders work, they often work
brilliantly. For instance, if you had set stop-losses two
years ago toward the end of the bull market in 2007, you
would have held onto a lot more of your gains from previous
years. Consider these examples:
Stock
Sale Price Using 20% Stop-Loss
Order
Current Share Price
Citigroup (NYSE: C)
34.52
5.00
Dell (Nasdaq: DELL)
22.54
15.63
American Express (NYSE: AXP)
46.96
35.09
Dow Chemical (NYSE: DOW)
33.20
27.07
Source: Yahoo! Finance. Stop-loss
price based on closing price on Oct. 15, 2007.
A stop-loss order could have
saved you thousands of dollars in losses. And that's
after taking into account that these stocks have all made big
gains since their lows.
Stop-loss orders are far from perfect, however. The closer
you set your stop-loss to the current share price, the more
likely it is to get triggered. And if the move that triggers
the order turns out to be a brief correction before a big
move up, then you could end up
selling at exactly the wrong time.
For example, if you'd bought stocks last November at their
lows, then by early January, you had some pretty strong
gains. Setting stop-losses would have saved you from the
following drop in February and March, but it also would have
taken you out of the ensuing rally. As you can see below,
that would have cost you plenty in some cases:
Stock
Sale Price Using 20% Stop-Loss
Order
Current Share Price
Wynn Resorts (Nasdaq: WYNN) Continued... |