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Every single one of Money Morning's experts advocates using them, and for good reason.
A "trailing stop" serves a dual role as both a risk-management and loss-minimization device. It allows investors to accomplish two things at once – capture profits and protect capital from catastrophic loss.
Here's exactly how this investment tool works…
How to Use Trailing Stops
A stop loss order is an order placed with a broker or online trading site to sell a stock at a given price. There are two basic types of stop limits you can put in place: a hard stop or a trailing stop.
A hard stop is usually expressed as a dollar amount. So if you buy a stock at $10 and set a hard stop at $8, your stocks will automatically sell if the share price for your stock falls below that amount. In this case, you've limited your loss ($2) to 20% of your original position in the stock.
In contrast, trailing stops are typically expressed as a percentage of purchase price. For example, if you buy stock XYZ at $10 a share, a 35% trailing stop calculates to $6.50. If the stock drops to $6.50, the order would execute and carry you out of the trade automatically.
But here's where "trailing" comes in…
With a trailing stop, the exit price increases in lockstep with the market price. That means the "stop" price – the price at which the stock will be sold – is adjusted as the price fluctuates, so if the stock runs up, the trigger price moves up, too. For example, if XYZ climbs and closes for the day at $15, your stop also increases to $9.75 (35% of $15 = $9.75). If it continues to rise to, say, $20, the stop would again automatically stop up, this time to $13 – thereby locking in a profit of at least $3 if the price took a tumble from there. (In fact, it's best to adjust your stop more frequently than that.)
And that's just one reason to use this investment tool…
About the Author
Ernie Tremblay has more than 25 years of experience in following and analyzing the latest developments in health, medicine, and related technologies. He understands the FDA approval process, as well as the "hard science" behind new, experimental drugs and the market demand for them - and has a comprehensive grasp of the complex dynamics that determine whether a new drug will be a breakthrough winner, or just another casualty of the FDA approval process.