Friday, October 5, 2007

Why We Use Trailing Stops

So we sold LDK Solar from the portfolio, and today it gaps up 5%. I know this is galling, even maddening on some level. But if you're serious about beating the markets, I have only this to say: Finding a strategy that works for you and sticking to it, even when it hurts a little, is absolutely critical.

Normally, I will place a trailing stop of 25% behind the positions we add to our portfolio. That means that we'll sell the stock the morning after it closes 25% or more below its high since being added to the portfolio.

The simplest way to understand it is with this example:

If we buy Stock XYZ at $10 and it closes at $7.50 (25% off its high) the next day, we sell upon the opening bell the following morning.

The reason we do this is simple: Rather than holding on and hoping the stock will rebound, we cut the losers and, as Alexander Green of The Oxford Club says, we let the winners ride.

Hey, it's not like we aren't giving the stock a chance to soar... just as long as it doesn't retrace too dramatically.

If it does, we sell and move that money into another stock poised to take off.

Our System Ensures that We Never, Ever Take a Catastrophic Loss

The beauty here is that you'll never, ever take a major bath on an investment this way. The Trailing Stop discipline makes sense, and I use it with this blog because my purpose isn't just to add stocks to the portfolio and hold onto them randomly until I get some big numbers to crow about.

We're seriously trying to beat the S&P 500 over the long haul... and we're willing to take our losses when we have to in order to accomplish this goal.

Anyway... more on trailing stops at a later time. For now, let's let the portfolio settle in and see if we can lasso another LDK-like return.



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