Taking the Reins of Your Investment Portfolio
"Buy and hold" is alleged to be a favored philosophy among many of the world's greatest investors, but that is an erroneous assumption. Buy and hold was a successful strategy years ago, when most investors were savvy institutional investors and commissions were so high as to dissuade frequent trading. Buy and hold was a valid strategy before the advent of the internet, discount brokerages, rock-bottom commissions on trades, and before the average mainstream consumer became an avid amateur stock trader. Today, even those who once vehemently promoted "buy and hold" strategies are coming out saying that it is no longer effective.
Most publicly traded companies actually want you to hold onto your stock in their company for long periods of time, if not forever, and for good reason too. When you sell, that company's market value diminishes. However, when you hold onto the stock their market value increases. This is good for the company, but not necessarily for you. The fact is, it would be dangerous, and irresponsible even, to buy stocks without ever selling some because you run the risk of wiping out large amounts of your portfolio (or worse, your entire portfolio) in one fell swoop. The best way to avoid this is the stop loss order.
Placing a stop loss order tells your broker to sell off part or all of your shares in a stock if its value falls below a certain threshold. You can set whatever price you want. Whether you choose to base it on technical or fundamentals is totally up to you. By the same token, you can instruct your broker to lock in your profits whenever a stock's price rises above a certain threshold.
When comparing your investing strategies to someone like Warren Buffet, for example, who appears to be buying and holding, you must realize that for the most part he is buying controlling interest in a company, so that when there's a problem, he can decide how to fix it. You, however, will not be so influential in the course changes and business decisions the companies you invest in are making.
Therefore, you need to stay on top of these investments, stay in as long as indications are positive, and then get out the second they turn to avoid being burned. Remember, there are individual and institutional investors much savvier than you, and they will often have sold off their shares in a failing stock before you even catch wind of the turning tide. That is why it is imperative that as soon as you clue in, you take action. Warren Buffet's action could be to change the company's direction. Your only action is to protect your principal.
If a publicly traded company goes bankrupt, the vast majority of its shareholders get totally wiped out and never receive any compensation for their loss. However, most of the creditors on a bankrupt company's ledger get some sort of compensation for their troubles. But your shares are not a lien on the company. They're just a bet you placed on the company's potential.
In your research you'll no doubt come across other "loss recovery" techniques, but before you decide to implement any of them, study them carefully. You could never unload enough covered calls, for example, to bounce back from a stock that suddenly becomes a so-called "penny stock." And you'll never buy a single put on a stock that's been delisted from its exchange. But a stop loss order is a fairly safe bet. The worst you could do with a stop-loss order is miss out on a gain. The worst you could do without one is watch your portfolio's value sink to nothing.
Kenneth C. Kelly is the President of Strativia, a financial management software development and services company specializing in applications for personal and business use. Strativia is the developer of Budget Forecaster, a sophisticated home budget and personal finance management software package. Website: www.strativia.com. Contact: info@strativia.com.
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