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How to Place STOP LOSS Rules
TRADING RULES EVERY SHORT TERM TRADER SHOULD LEARN (Written in July 2001)
The following TRADING RULES section is from a book by Steve Zito of Stock Market Direction
(http://www.reocities.com/steve_zito). It is not to be reprinted without explicit written permission.
---------------------------------I am currently using two simple trading rules.---------------------------------
First, if you get a 35% gain in a short period of time, take the gain. The logic is that most people would be happy to make 35% in a year. If you get that in a week or two, don't be greedy. Take your profits.
Second, always use a STOP LOSS order, and place it at a price 5% below the market price as soon as your stock purchase is filled. If you buy a stock and immediately your stock goes down, you will be able to limit your loss to 5% plus commissions. If your stock goes up, it will not decrease your trading profits.
Each day, re-evaluate and raise the STOP LOSS order to keep it 5% to 10% below the stock's market price as it rises. Eventually the stock will have a day of profit-taking and you will get STOPPED OUT, but on a rising stock, this also guarantees locking in a profit. If a stock falls more than 4% right after you bought it, getting STOPPED OUT confirms YOU MADE A MISTAKE, so why not limit your mistake to 5% instead of 10%, 15%, 25% or as some have experienced, 100% loss (ENRON, Global Crossing)?
I once bought a popular stock MUEI at $14.00 that was touted by Pat Bolland, CNBC Stocks Editor, as trading higher after reporting its record profits. The $14.00 MUEI went down $2.00 the very next day. I had no STOP LOSS. After all, Pat Bolland, Sr. CNBC Stocks Editor had told his CNBC viewers on camera emphatically about MUEI's great RECORD EARNINGS. Over the six months after I bought it, MUEI lost 88% of its value despite record earnings, falling steadily from $14.00 to $1.60. I never sold it, did not have a STOP LOSS, and lost 88% of my investment value. I kept hoping MUEI would rebound, every day reminding myself, "RECORD EARNINGS" reported by a CNBC Stocks Editor means it will come back. It never has and after doing some homework, I suspect it never will. The stock was that of the fourth largest Personal Computer direct seller, but manipulated and controlled by its parent company, Micron Technology, which owned half the outstanding shares. As for that Pat Bolland, the last time I listened to his advice (in July 2001), he was talking about some "ascending triangle" in Exxon-Mobil's chart and telling viewers "XOM patterns" had an extremely bullish chart formation which meant record high prices coming for Exxon-Mobil (then $44). Since, Exxon-Mobil stock has gone down and sideways. Stocks Editor Pat Bolland a foreigner, he can be excused for not understanding how U.S. stock markets work. He looks intelligent with his "bow-tie," unfortunately, when he opens his mouth he ruins his image.
Don't wait for stocks to turn around. If a stock goes down more than 4% after you bought it, then YOU MADE A MISTAKE. Do not compound your mistake by letting the losses get larger. This is the most common mistake made by investors who hold on to a stock waiting for it to turn around. Stocks are not your "children," so do not "fall in love with them," like CNBC's Pat Bolland, who they said has 10 kids.
I learned at university in graduate level Finance courses that "buy and hold" is the most profitable stock strategy in the long run. These Finance theories were created by Finance professors who are notoriously bad investors, and these theories have been propagated by mutual fund managers who earn their living off fees assessed as a percentage of assets under management (mutual fund management fees). The more assets they control, the higher the revenues from fees and also the size of their salaries, bonuses, perks. They want YOUR MONEY to go in to the mutual fund, and never leave the mutual fund. Trading in and out of funds and capital depleting transaction costs defeats mutual fund management fee structure profits. Read your mutual fund prospectus if you don't believe it. Have you ever read a mutual fund prospectus? When you buy a car, you read the purchase agreement, don't you?
Ever wonder why the biggest mutual fund guru of them all, Fidelity's Peter Lynch, tells you in TV ads to stay the course and ride out volatility (which means don't ever sell)? This message helps to keep investors fully invested even in bear markets, so that Fidelity's managers can make more money off a larger base of Fidelity's customers invested assets. Ever wonder why President of Fidelity Group is often a lawyer? So if Fidelity makes a mistake with an account, investors would never win a dime in arbitration. I know, Fidelity forgot to place a "stop loss" on my last position in Metromedia Fiber Network in June 2001, and I lost my entire investment. Fidelity restricted my account, refused to discuss the mistake, closed me out, and my arbitration has cost me $4,000 with no guarantee of success (documented July 2001 SEC dispute filing). I made over 100 trades with Fidelity in the 2001 trading year (at $15), and on the very last trade, Fidelity stiffed me for my entire account value resulting from their obvious broker's Stop Loss omission. In fact, of the ten different electronic brokers I have used, Fidelity Investments electronic interface is the most unreliable, often delaying sell orders for five minutes. Don't believe it? Try placing open sell orders at 3:55 PM EST with Fidelity Investments. If you make day-trades with Fidelity Investments, set aside at least $2 for arbitration for every $1 you invest or trade.
In the real world, from the investor/customer viewpoint, the most profitable strategy is to cut your losses early and run, and let your profits build on the winners. If you buy five stocks one at a time investing the same amount in each stock, and not buying the next until you sell the first, and get STOPPED OUT of four of them with 5% losses on each, you have lost 20%. If you can make 35% on the remaining winning stock, you have not only covered your losses, you have gained a NET 15%. In the real world, it is very hard to buy five stocks and pick four losers out of five. Try it. I have two advanced Masters degrees in Finance and Accounting, and twenty years of trading experience. I have been able to select short term winners 80% of the time. My +119% one-year real-time gain trading a model portfolio from 2000-2001 can be verified by visiting my Stock Market Direction Model Portfolio page. Over 127,000 readers of my Home Page read every trade posted day-by-day real-time. Or you can log in to the latest TechTV Investment Challenge, register for free, check out TOP 20 for S-ZITO. Many times there are 10,000 contestants, but I am usually in the TOP 20. In the last TechTV Money Machine contest in June 2001, I was the Second Place winner by only $4,000 on a $1 million portfolio! (4th Jan. 2001, 20th April 2001)
Remember, BUY and HOLD the WINNERS, but CUT the LOSERS OUT OF YOUR PORTFOLIO. You may be discouraged with a lot of 5% losses that also lead to a lot of commissions. But one 35% winner covers four 5% losers if you invest the same amount of money in each of the five stocks. For keeping commissions to a minimum, get a discount broker with the lowest commissions. Many online brokers offer low $5 trades, trade only NO-LOAD sector MUTUAL FUNDS with Fidelity or Vanguard. If you go with Fidelity, read Arbitration Agreements carefully before sending Fidelity Investments a dime. I once called up Fidelity Group in 1987 to ask them where Peter Lynch was the day the U.S. markets crashed (Oct. 19, 1987) and I was told Lynch was on vacation fishing in Ireland and not taking any calls.
I firmly believe in what I am saying. If you have any questions, contact me. And remember, I graduated from the same university as Peter Lynch and Donald Trump. Profit from that, not by watching CNBC.
The preceding TRADING RULES are great for choppy markets, sideways markets, markets with no trend. On the other hand, if you know you are in a Bull Market, you do not need trading rules. What does matter in a Bull Market is Stock Selection. You want to make the maximum stock gains in a Bull Market. From 1932 to 1939, the Dow Jones doubled. IBM went up over 100%. That is great. IBM was a type writer company back in the 1930's. Their chief competitor, Smith Corona, went up 1000% in the same period (from $4 to $44). Why? Because IBM never sold off low enough in the crash of 1929 like the much smaller Smith Corona. IBM retained half of its value, the same way Microsoft retained half of its value unlike CISCO, SUN, and all the other Nasdaq stocks in the Bear Market of 2000. In the early stages of a Bull Market, you must be in the most beaten down stocks which have the greatest potential to turn around, just like Priceline.com from Jan. to June 2001. Priceline.com went up 725% in that 6-month period, and Microsoft went up 70% (from $41 to $70). Which was the better stock to buy near bottom? In my own personal experience, I bought almost 2,000 shares of Advanced Micro Devices on Oct. 16, 1990 under $4, the all-time low trade in AMD's history. Advanced Micro hit a high of $96 in early 2000.
Trading rules are meant to protect principal in choppy markets, sideways markets, markets with no clear direction, and not for trading Bull Markets. Trading rules by nature are defensive. In a Bull Market, you do not need trading rules. In a Bull Market you need Stock Selection (everything goes up). Nasdaq is not in a Bull Market, like CNBC says. When a new Bull Market starts, the daily Advance-Decline will run five to one for the first 2 weeks. Trading volume is not relevant. For 1 share purchased, 1 share is sold!
This article was written in July 2001, yet today WHEN I REVIEWED IT years later, everything that
I have written is still relevant. The investment world never changes. As investment players come and go.
If you found this page searching the KEYWORDS, Stan Weinstein "the 4 stages of the stock market"
please click here and read more about technical analysis on my Bulletin Board Page.
The preceding is for individual use only, and not to be reprinted, copied, distributed, or rewritten without explicit written permission from Steve Zito. This is from my copyrighted book.
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