If your are interested into finances and the stock market you may have found this out by yourself: stocks mostly offer better returns than managed investment funds plus they are cheaper to buy since they don’t come with a management fee or issue surcharge. On the contrary you have to do all management of your stock portfolio yourself and have no manager looking after your stocks on a day to day basis, securing profits when you are not watching or simply on holiday.
So, is there a stress free way to manage your stocks and secure your investment at least to some degree? One smart way is to let the computer system of your preferred stock exchange (I use Tradegate or Xetra since I live in Germany) do the management for you. This way you can maximize your profits and reduce the risk of loosing money at the same time.
Let’s delve into this….
Step one – Select and Buy stocks
If you haven’t done this already: You first have to buy some stocks. I tend to buy stocks in the sector where I believe I understand the market and it’s influences the most and can anticipate future developments and future trends. My sector is technology :)
I anticipate trends like: Paper job applications will be eaten up by Linkedin profiles in a couple of years. Microsoft Windows XP will expire around April 2014 which will lead to many companies buying new software and hardware for their offices. The significance of Tripadvisor will continue to rise since more and more people are exploring cities and sights with their smartphones.
But beware: We’ve seen in the 2007 stock market crash that even when the economy is healthy – in a blink of an eye the situation might become very different.
Step two – Setup Stop-loss orders
So, what can you do to protect your investment without monitoring stock charts every hour or so? Most exchanges for private and corporate investors offer the „stop-loss“ order. Used wisely it can provide a parachute for your investment costing you near nothing. So, how can you use it?
Simply put, a sell stop-loss order just sells the specified amount of stock when a certain value is reached by the stock chart. So, for example, if your Company A stock is decreasing in value and you have set your stop-loss order to sell all Company A stocks when they hit $50 per share the computer system will automatically process this transaction when the specified value has been reached. For example if you bought th Company A stock when it was $40, it then shot up to $60 and you set your stop-loss order at $50 to prevent loosing money, you’ve made a profit of $10 per share. The computer system of your exchange will just take care for you if the stocks fall under a certain value which you specified. So, a stop-loss order is a very simple concept which you can easily understand. But anyway, wouldn’t it be nice if you sold your stock closer to the $60 mark? Read on…
Step three – Advanced tactics with dynamic stop-loss orders
The more advanced way to secure your stocks would be to use the „dynamic stop-loss“ or „trailing stop-loss“ order.
Like in the example above, your Company A stocks are worth $40 per share when you buy them. You expect them to rise but you want to secure your investment setting a trailing stop-loss order 10% below the current price (gap) which would then be $36. Now the price per share of Company A stock climbs to $60. What happens to your trailing stop-loss order? It will adjust automatically to keep a gap of 10% below the current stock price. At $60 per share the stop-loss order would have risen to $54. Now, the Company A stocks plummet to $50 per share. When it reaches a valuation of $54 per share the exchange computer system will execute your trailing stop-loss order and your Company A stocks will be sold „best“ to match open buy orders. So with heavily traded stocks (NASDAQ, Dow-Jones, DAX… Bluechips) the price at selling should be pretty close to the actual value of your sell stop-loss order.
In contrast to the first example with the simple stop-loss order – you now got $54 per share instead of $50 which leaves you with a plus of 8% in that particular example. Not bad – considering the technology did the monitoring work for you.
Up Next – Determine the ideal gap
In the next blog post, I will share with you three ways for determining the ideal gap between the current stock value and an ideal stop-loss value. So, stay tuned.
Let me know what you think on in the comments section and like maknesium on facebook if you want me to keep you updated. Thank you :)