(May 16, 2011 update: All future stock posts will appear on my new subscription-only website at www.GoodfellowLLC.com. Please visit!)
A stop order is a stock transaction wherein you arrange to sell your stock IF it drops to a certain level, but otherwise you keep it. At my brokerage firm (Morgan Stanley), it costs me nothing extra to place stop orders, cancel them, or change the stop price.
Here's an example: let's say I own 100 shares of Microsoft. This stock has been mostly trading between $22 and $31 for ten years. If I buy at $22 and the stock rises to $29, I'm pretty excited, but always sort of worried that it will fall back down and my profit will erode, right? So I put in a stop order at $26.50 good-til-cancelled (gtc). The order stays in the computer until the stock falls to $26.50 and sells, or until I cancel the order, or until I change the order. For example, if the stock rises to $31, I would probably raise the sell order to $28.50, to protect more of my profit.
Recently, the market took a downturn, and 20% of my stocks sold on stop orders. I got out with profit -- not as much profit as I had at the highs, but enough that I am happy I did it. Now I have a large chunk of cash with which I can go bargain hunting during the market downturn. I will not spend it all at once, but neither will I be afraid to spend it.
The first couple times you have a stock sell using a stop order, you're going to be emotional. You might be emotionally attached to the stock and wish you still owned it. You might worry that it will bounce back up and that you sold it for no good reason. You might obsess over these things and learn that you're too emotional for this aspect of stock investing.
But if you look at stock investing as just another way of making money, this might work well for you. When the stock sells, look at the cash and be calm. Find a way to reinvest it. If you're not going to find a better opportunity, i.e. a stock that has better prospects to go up, then you're going to regret selling Microsoft. But if you wait and buy Microsoft back cheaper, or buy another attractive stock which is low in a very solid trading range, or buy a stock which didn't fall at all during the market downturn, you will likely be pleased that you found a new investment strategy which helps you buy low and sell high.
Happy investing!
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The Right Huff is Crista Huff's blog for politics and items of sociological or financial interest. Crista Huff also manages Goodfellow LLC, a subscription-only stock market website. We strive to identify financially healthy companies in which traders and investors can buy shares and earn dividends and capital gains. See disclaimer for the risks associated with investing in the stock market. See your tax advisor for the tax consequences of investing. See your estate planning attorney to clarify beneficiary and inheritance issues associated with your assets.
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