Stop now to protect profits
May 7, 2013
With the Dow hitting all-time highs, most investors are looking at profits in their portfolios compared to this time last year. Analysts are mixed as to why the Dow has moved so convincingly, and the theories run the gamut.
An improving real estate market, improving business fundamentals and a pick up in hiring have all been suggested as some of the reasons for the rising market. Massive money creation by the Fed and ultra-low interest rates also help to move investors into equities.
Whatever the reason or combination of reasons, the fact remains the market is up, and that means profits for anyone holding stocks.
For those investors looking at profits, it might be a good time to protect those profits, and this can be accomplished with something called a “stop” order in regard to stock accounts.
A stop order is entered with your broker as a sell order, but under “order type,” you enter “stop.” Don’t use a “stop limit” order, as this sets an entirely different set of rules for the order, and for novice investors, I always suggest using a plain old “stop loss” order.
A “stop loss” order can usually be set to last for 60 days and works like this:
Suppose you bought a stock at $20, and it’s now at $30. You’re looking at a handsome profit and don’t know which way the market will go. You want to protect at least some of your profit, so you decide to enter a “stop” order.
You enter the stop loss order at a price under the current price but above where you bought it. For this example, we will set our stop at $25. If the stock slips below $25, the brokerage will sell your stock at the next best price.
You might get $25 or maybe even a bit less if the market is falling fast, but the point is you are out automatically with some profit left. You can set the stop higher or lower depending on how much you want to protect. If the stock never drops to $25, the order expires after the time limit, and you have to then re-enter another stop order.
The downside on stop orders is you may get sold out in day-to-day market gyrations, then the stock may turn and run again, and you are no longer in. The further down you set the stop, the less likely that will happen, but you will also give up more of your profit.
Stops work well in most markets, and usually any firm will accept them on most securities. You just have to remember when they expire and re-initiate them if you wish to continue using stop loss tools.
One other caveat to stop orders is during the “Flash Crash” a few years back, many investors who had stops got taken to the cleaners. When the markets fell almost a 1,000 points in a few minutes, many stops were hit, and investors lost their stock only to find the stocks back up where they started by day’s end.
You can find stop order options under the trade tabs on your brokerage sites or ask your broker to learn more.