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Investing Without Brakes Is Hazardous To Your Portfolio
By: Francis Kier
The business of investing in stocks is an inventory “buying & selling” business.
Naturally, the companies that sell stock to the public want you to buy and hold
it forever in order to maintain its value. But if you are buying without any
selling, you are literally driving without any brakes. That is a horrifyingly
unsafe position for your principal. The most effective defensive brake system
for your money is a stop-loss order on your stocks.
A stop-loss order is an order you give your broker to sell your shares if a
stock falls below a certain price. You can select a stop-loss price for your
stock based upon chart patterns or a percentage drop from your purchase price.
And some brokers automatically move them as a stock moves up in price to lock-in
profits for you.
The first time I learned this lesson (not the last unfortunately), I was just 18
years old. One of my early stock purchases, recommended by a stockbroker from a
famous brokerage firm, was stock in a famous airline – just before it trailed
off into bankruptcy. Had I read this article before the airlines’ financial
calamity, I would have rescued most of my $5,000 and prevented my own financial
calamity.
But you cry, “The greatest investor Warren Buffett is a buy & hold investor!”
No, I’m afraid he is not. Mr. Buffett mainly buys whole companies or controlling
interest in a company. He buys control so that if there are problems with the
company, he can hire/fire/make changes. If there are critical problems with the
company whose stock you own, the only control you have to protect your principal
is to sell.
When a public company goes bankrupt, 70% of the time the shareholders receive no
money at all. How many stocks do you want in your portfolio worth $0? I know
exactly how many that I want, and I know that stop-loss orders prevent it from
happening.
There are a few “loss-recovery” methods, but you’ll never sell enough covered
calls to recover from a stock trading under $5, or be able to buy puts on a
stock that has been de-listed from an exchange. But the nearly certain
protection is to place a stop-loss order on the stocks you own. You can choose
any percentage loss amount (5%-25%) based on your experience, but you must have
a stop-loss order in place to protect your capital.
There a zillions of old stock market sayings. Here is one of them for those of
you who are still skeptical, “If the smart-money has sold and moved on, what
type of money still own the stock?”
About the Author:
Francis Kier has an MBA in finance and shares his two decades of experience with
investing and personal finance. More of his articles are available at http://investing.real-solution-center.com
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