The Stop Loss

When it comes to managing your own investment portfolio it is not enough to just come up with a winnings strategy for picking stocks. You must be able to effectively manage losses when they do occur in order to maximize profits.

One tool that is highly effective in limiting your losses to an absolute minimum is the well known stop loss. This order is placed to assist in liquidating a particular position once the stock has fallen below a certain percentage of the purchasing price.

For example, say you buy 100 shares of IBM at $91.41 per share and want to place a stop loss of 10%.

>>First, you can calculate this by multiplying ($91.41*.10) which equals $9.14. This would represent the movement in price you are willing to give up before cutting your losses and finally selling out.

>>Next, take your buying price and subtract the dollar value of the stop. In this case ($91.41-$9.14) = $82.27. This represents the stop loss price for your next step.

>>Finally, you will place a stop loss order to sell a specific number of IBM shares at $82.27. However, if you are able to place a stop loss percentage instead of a price you would indicate the number of shares you want to sell and then type in the percentage loss (10%).

Note: Although placing stop losses will save time and prevent you from having to constantly monitor your stocks, there are some considerations to make. Stop losses are placed through market orders that are subject to the volatility of a particular stock so there is a chance that you may incur steeper losses before finally exiting a position. Also, keep in mind that commissions charged for selling out of stocks can have an impact on profits/losses. This is why it is important to know the personality of the securities that you purchase. If a stock fluctuates back and forth at greater percentages than your stop loss allows then you will find yourself being stopped out too early and too often.

Furthermore, if you would like to maintain an easy rule of thumb for placing stop losses keep the following in mind:

Active Trader :: 5% Stop Loss
Intermediate Horizon :: 10% Stop Loss
Long-Term Investor :: 15% Stop Loss