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Newton’s Curse Puts Investors at Risk

Louis BaseneseStocks have outperformed nearly every asset class since the 1920s.

And that outperformance only improves when you focus on recent history.

Since the rally began just over eight years ago, the S&P 500 has nearly tripled. The current bull market is the second-longest run for U.S. equities on record.

But as you know, the laws of gravity apply in the financial market just as they do in the physical world.

What goes up must come down.

And it’s the fear of that eventual decline that keeps investors up at night.

But fear not, friends.

Today, senior analyst Jonathan Rodriguez will run through one of the best weapons at an investor’s disposal to defend against shocks.

Ahead of the tape,

Louis Basenese
Chief Investment Strategist, Wall Street Daily

The Easiest Way to Survive a Stock Apocalypse

Jonathan RodriguezWarren Buffett, one of the stock market’s most successful investors, has a simple rule about investing…

“Never lose money.”

I couldn’t agree more.

But risk — and how we manage it — is a huge part about investing.

Of course, risk means different things to different people.

The most conservative investors are willing to sacrifice profit potential to ensure they don’t lose their shirts.

On the other hand, the market’s most aggressive investors often make huge bets on stocks with little regard for downside.

The truth is a healthy balance between the two mindsets will help investors book consistent gains and preserve capital.

Here is a little-used investor tool that can help you to do just that…

Stop, Drop and Let Your Gains Roll

The easiest way to protect yourself from a stock shock is the use of sell stops.

A sell stop is simply a standing order with your broker to sell shares of stock if they fall to a certain price level.

Generally speaking, there are two types of sell stops: stop losses and trailing stops.

A stop loss, or hard stop, is based on a hard price level that you set on your own.

For instance, let’s say you’re sitting on a 50% gain on Apple shares, which trade for around $143. But you have a feeling the stock might drop in the near term.

Instead of selling your position, placing a hard stop at $130 would lock in a 37% gain but require the stock to fall by 9% before tripping the order.

In other words, you give the stock some wiggle room so you’re not stopped out of the trade — unless it experiences a massive downward move.

Best of all, if Apple shares continue to rise, you can continuously raise your stop and you won’t incur any brokerage fee unless the shares “trip the wire.”

But what if you want a stop in place but don’t have the time or wherewithal to actively manage it?

Well, you’re in luck…

A trailing stop gives you the best of both worlds.

A Sell Stop on Autopilot

Think of a trailing stop as a hands-off, virtually idiot-proof safety net for your investments.

It works just like a stop loss, but instead of setting a hard limit price, you choose a loss percentage limit (such as 10% or 20%).

A trailing stop on a stock rises automatically as the shares do. Hence, they “trail” your holdings.

For instance, let’s say you buy Apple shares today at $143 and set a 25% trailing stop. The stop is set at $107.25.

And no matter what happens to shares from here, you’ll lose no more than 25% of your purchase price.

If shares move up to, say, $153, the stop rises to $114.75.

This protects you on the downside while allowing your winners to keep running.

The key for a good trailing stop is to choose a percentage that’s tight enough to give you comfort on the downside but wide enough to withstand a little volatility.

After all, you don’t want to get stopped out of a good stock on a brief drop only to watch the stock rip upward on the chart.

For low-volatility large caps, 25% is a solid trailing stop for most investors. And for volatile small-cap and microcap issues, investors might consider a stop between 30% and 50%.

No matter which type of stop you use or threshold you set, stick to it. The market’s most successful investors know when to cut their losses — allowing them to trade another day.

Bottom line: The use of sell stops may seem like a no-brainer, yet many investors don’t use them. Armed with these simple, easy-to-use tools, you’ll preserve more of your hard-earned capital — and profits.

On the hunt,

Jonathan Rodriguez
Senior Analyst, Wall Street Daily