When it comes to the stock market, everyone will tell you that it is impossible to accurately predict the future. But there is one strategy that will help you to maximize your profits. It will help you survive the bad stocks in your portfolio.
This method is called a trailing stop loss. A stop loss is simply an order for your stock broker to sell your shares if the price falls to a certain price that you have pre-specified.
How do you know what price to set as your stop loss? There are two methods. Many people simply decide what percentage of their investment they are willing to lose. The rule of thumb is usually 10%. Figure out what price this would be and set your stop loss at this level. When the price of your stock increases, simply recalculate and move your stop loss up to a higher level. Many brokers offer a trailing stop loss service. You don't have to keep recalculating and calling the broker. You simply tell them the percentage and they take care of the rest.
The second method is more complicated and is often used by more seasoned investors. Markets go up and down. A stock will rise, then fall. It does this over and over again, rising a little more each time. The idea is that you study the ups and downs over a length of time and set the stop loss at just below the lowest dip. This takes a little more work than the first method.
The stop loss strategy is very effective, but only if you use it. You can't think that a price will rebound, so you change your stop loss. This invites more risk. Sometimes you will be right, but in most cases the price works against you. Remember, if a price falls 50%, it will have to increase by 100% to hit zero. And rarely do stocks rebound 100%.
There are instances in which the stop loss isn't completely effective. For example, the market could fall so drastically that you are bypassed. There are regulations that guide how far a price can fall in one day. If the price falls this maximum distance, your stop loss has probably been bypassed. Your broker will not be able to sell at the price you set for your stop loss. The market just moved too fast. This rarely happens, but you should always know the risks.
Using the trailing stop loss method will help you keep the gains that your investment has made. Make sure that you adjust your stop loss as necessary. You would hate to see a price bounce up and then fall back down, only to miss out on the profits. The stop loss is an effective way to set unemotionally attached outs on your stocks. When you have a hard percentage rule set, it is easy to follow it. You aren't as tempted to just ride things out. You simply say, I've lost 10%, I'm done.
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