Financial Musings of a Burbank CPA: Letting your investment winners run and protecting your downside Part 4 of 5

This article continues my five part newsletter series I published a couple of  years ago on investments – Letting Your Winners Run and Protecting Your Downside (this stuff never gets old!)

Part 4 0f 5 – The Trailing Stop Loss:

Ok, you are in your investments; now when should get out of them?  The answer is the trailing stop loss. When you buy an investment, set a stop loss of 15 – 25% of the investment value; if the asset drops that amount, you sell on the market opening the next day (this will prevent a sudden drop in price and rebound, called a whipsaw, taking you out of an investment by hitting your stop loss then rebounding back above – wait until the close and see if you are still below your stop. Also it is not a good idea to log your stop losses in with your broker as they will be automatically exercised instead of waiting for the close; keep them in your head or on a spreadsheet.)  The 15 – 25% stop loss will keep you in the trade long enough to give the investment time to become profitable without stopping out too soon.

The reason to use a ‘trailing’ stop loss is that when the investment moves in the direction you want it to, you move your stop loss up to protect your profits – if you start with a 20% stop you continue raising the stop until you are stopped out. The best part of this strategy if you follow it is you know when to sell an investment (the hardest thing to do) and you don’t have to think about it or agonize over it, you just follow the stop and sell when it tells you to. This strategy keeps you in the investment while letting your winners run; they go up and when they start to drop you can tighten the stop a little if you want to protect profits or stick to what you already have – when you hit your stop, you keep most of your profits.

Next time in the final segment of this series, I will put things together and show how these items working together will limit your exposure and minimize losses and protect profits. 

 Financial MgmtDollar holding Dollar Bill 2012 For financial,  accounting and tax musings,

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