If you buy a stock and its price drops, sometimes your best option is to cut your losses and sell the stock. But unless you're a full-time trader you likely don't have time to vigilantly monitor the stock price so you can sell it off before it falls too far. That's where a stop-loss order comes in handy. You can use a good-till-canceled (GTC) stop loss sell order to automatically sell a stock after a predetermined price drop. A GTC order is valid for up to 60 days; a stop loss order is triggered when a stock price drops to a specified level at which it becomes a market order and is executed at the next market price.
1. Buy stocks on a breakout from a base or a consolidation area. Buying breakouts increases your chances of making a profit and reduces the possibility of a loss, because a stock in a breakout is most likely to go up and least likely to go down. It takes time and study to learn to buy breakouts, but the effort is well worth it.
2. Set the initial stop loss sell order 5 or 10 percent below the correct pivot point. For example, if the correct pivot is $24.88, the initial stop loss order should be set at $23.63 for a 5 percent stop loss, or $22.39 for a 10 percent stop loss.
3. Watch for the stock to establish a new trading range. A stock in an uptrend makes a series of higher highs and higher lows. If, instead, a stock makes a lower low, this can indicate a change of direction from up to down, which can lead to a further decline. For example, if after the breakout your stock trades between $24.38 and $28.71, it should be sold if its price drops below $24.38.
4. Subtract 10 cents from the low, or round it down to get your stop loss price: $24.28 or $24.30 would be the correct amount.
5. Move your stop loss sell order to $24.28 or $24.30 as soon as the stock makes a higher high.
6. Continue to move up your stop to just below the most recent higher low as soon as your stock makes a higher high.
- Use daily stock charts to buy breakouts, calculate pivots, find the most recent higher lows and determine stop loss sell prices.
- You should avoid having more than a 5 or 10 percent loss in a stock position. If your stop loss sell price is more than 5 or 10 percent below your purchase price, you may have overpaid for it – that is, the price may be extended from the correct buy point and due for a pullback. Some investors calculate the stop before they buy a stock so as to make sure that they do not overpay.
- Avoid using automatic trailing stop loss sell orders based purely on a fixed percentage of a purchase price if you do not buy on a breakout. A stock’s normal fluctuation can trigger your stop loss unnecessarily. If you buy a stock at an arbitrary price, your stop loss sell price will also be arbitrary and will very likely be triggered in a normal pullback.
- “Stan Weinstein’s Secrets from profiting in Bull and Bear Markets”; Stan Weinstein; 1988
- stock market crash image by Paul Heasman from Fotolia.com