subject: Red Alert: Stop Losses Necessary Before Proceeding [print this page] Small-cap investors have to be wary of the risks they take. Yes, its true that penny stocks are leading a potential rebound on Wall Street, and paving the way for economic recovery. But there are many roadblocks along the way. And wise investors are ones who do their research on any stock small-cap or otherwise before putting their hard-earned money into it.
Before following the herd and going for whats popular, its best to know if a penny stock has any real value, and any real chance for consistent growth. If those traits arent there and if there are other red flags flying just move ahead to the next stock. Dont waste your effort.
With that said, once you find the right penny stocks, you can go ahead and put your money down in them and watch it grow. But how are you supposed to know when a small-cap has reached its peak and wont go further? Well, we here at Penny Sleuth have a proved strategy that can help you out
Use Stop Loss Orders to Protect Your Gains
The best defense is a good offense. Though the adage may be overused these days, it holds that the surest way to victory is often achieved through action not just by waiting for your enemy to attack. The same is true of investing.
As I write this, were sitting at the top of a historic rally; since the market found its most recent low in March, the S&P 500 index is up nearly 34%. And more and more cautious investors are becoming nervous. After all, how much higher can the market go in such a short time period?
That building sense of investor queasiness could turn into a self-fulfilling prophecy when all of these jumpy stock buyers become sellers at the first sign of a pullback.
We may be just 4-5% away from the next technical stumbling block traders are watching out for the 200-day moving average of the S&P 500.
As the S&P climbs nearer to the red line, you can expect technical analysts to watch intently. Trading off these movements is their bread and butter. What that means for fundamentals guys is that we should be watching our portfolios very carefully right now.
But there is one very good way to protect your gains right now its called a stop loss.
Basically, a stop loss (or stop, or stop order, etc) is an order with your broker to sell your shares in a particular stock automatically when its price hits a specific level. That means if your shares of Stock A are up 30%, you can set a stop loss to trigger when the stock drops to 25%, guaranteeing your minimum profit.
While there are several different types of stop losses, these three flavors are worth knowing about:
1.Stop Order: Triggers once your stock reaches a specific target price, the stop price.
2.Trailing Stop: Triggers at a specific change in price, measured by either percentage points or dollar value.
3.Stop Limit Order: Similar to the stop order, except for the fact that a limit order is triggered once your stock reaches a specific target price. (i.e. sell high, and re-buy low)
Clearly, the biggest benefit of placing stop losses is the fact that you wont have to lose sleep over your open positions if the stocks you own take a big dive, your positions will sell off before any major damage is done. Thats a pretty compelling case for using stops.
Still, thats not the whole story
Drawbacks of Stop Losses
The biggest reason that people lose out on stop losses is through short-term fluctuations in stock price. If you have a stop set at 5% below a stocks current price level, and the stock swings 10% in the week, your stop will trigger and youll miss out on the stocks rebound. As a result setting your stop losses intelligently is essential.
But exactly where to place your stop-losses is another tricky bit of business. It takes even the most skilled traders a good bit of trial and error to learn what works when it comes to setting stop losses.
If youre a believer in fundamentals, its best to think of stop losses as profit keepers. You should place them at the level of gains youre comfortable walking away with. If one of your positions is up 20%, 15% gains may be the least youre willing walk away with if thats the case, it makes sense to put your stop losses there.
Even if youre a fundamental investor, stop losses can be most valuable when theyre combined with technical analysis (using chart patterns to determine where a stocks price is going). After all, technicals are what drag fundamentally sound companies down during a bear market. Unlike with fundamentals, where stop losses can be considered profit keepers, you can think of technical stop losses as insurance a way to ensure that your stock wont go into freefall.
Stops can be very useful when theyre placed under a stocks support level (the price level that a stock has trouble falling below). Thats because to a trader, a price level below support generally means that the stock could be breaking out much lower.
Dont Stop the Stops
Whatever your investing strategy, stop losses can be a valuable part of your investing toolbox. That said, using stop losses and other more complex broker orders can be tricky for beginners always make sure you understand what youre doing before you commit money to a trade. Here at the Penny Sleuth, well keep doing our best to provide you with an investing education.
Meanwhile, its best to remember that stop losses are best used when placed in conjunction to some warning signs that come up in the investing world. After all, penny stocks are unique, and savvy investors would be wise to note that there are dangers out there that could take down their investment returns. By using caution, they are better prepared to use their stop losses and make sure they preserve the gains theyve made out on the open market.
Ill show you what these warnings red flags if you will are nowwe deal with them here at the Sleuth all the time
Three Red Flags for Penny Stock Investors
Here at Penny Sleuth HQ were often asked what we think about Company A, or Stock B, or Product C. Maybe often isnt strong enough of a word we get these emails by the hundreds! And while we cant offer individual investment advice, we certainly can give you the tools to analyze these stocks based on the years weve spent in the penny stock trenches.
Most investors realize that theres something very different about penny socks. After all, how can the smallest companies out there offer some of the biggest returns?
But while small-cap profits can be bigger than those youd see with a company like General Electric or Exxon Mobil, there are still three red flags that you should be watching out for in your penny stock investments right now: lack of liquidity, paper thin margins, and sparse volume. Keep these three items in check, and your chances of investing your way to profits in 2009 will be greatly increased. More on that in a minute
1. Lack of Liquidity
When fundamental investors (people who invest on stocks based on their business, assets, and growth potential) talk about liquidity, theyre referring to balance sheet liquidity a companys ability to convert their assets into cash in a pinch.
Thats a pretty important characteristic right now.
After all, while cash may seem in short supply during this recession, the small-caps we focus on wont be getting any bailouts from Uncle Sam anytime soon. Thats why its so important to make sure that youre putting your money in companies that have the wherewithal to survive for the long-term.
When looking at a companys balance sheet (which you can find for free at sites like Google Finance), the first thing to remember is that cash is king during a recessionthe more cash a company has in the bank the longer theyll be able to survive if times get tougher.
Another valuable measure of a companys staying power is its interest coverage ratio. The interest coverage ratio divides a companys earnings before interest and taxes (EBIT) by its interest expenses, and gives investors a glimpse at how easily a firm can make its debt payments. A number above 1.5 is generally a good sign.
2. Paper Thin Margins
While larger companies usually keep their margins in line from quarter to quarter and from year to year, smaller companies dont always have that same consistency. Net margins, which show what percentage of sales translates to profit, give investors a good idea of how susceptible a company is to declining revenues.
When margins are exceptionally small, watch out it could mean that your company is a quarter or two away from posting a loss.
The most important thing to look for with a companys margins is the way they behave over time. Slipping margins could be a sign that a company is losing its footing, whereas slow margin growth could mean that the company is becoming more efficient at turning a profit.
3. Sparse Volume
While our first two red flags focused on a companys financial statements, sparse volume is all about the stock market. A stocks volume is a term used to describe how many shares traded hands during a given period. Average daily trading volume is a pretty common indicator of how frequently a stock trades, and you can find it just by going to any stocks Google Finance page.
Volume is important for a very good reason stocks that dont have a decent amount of trading activity are incredibly unpredictable. Thats because in the stock market, we the people who buy and sell the stocks set the prices. When a stock has low volume, it means that a small number of people have control over that stocks price, and a relatively small number of shares can drastically skew a companys value.
It also means that other investors arent particularly interested in investing in that company. Thats significant because it means that even the best companies can stay undervalued for long periods of time if they dont have reasonable volume.
Make sure your small-caps trade daily, or you could be locked in a waiting game to make money on your investment.
Building a Better System
Keeping an eye on these three red flags is a good start when youre trying to analyze a new penny stock. Remember though, all three of these measures are subjective, so itll take some experience before youll be able to discern the difference between liquidity thats good or just average.
Its always a good idea to watch the market and follow the technical analyses for yourself, instead of just depending on what youre hearing from the herd of other investors of the mass media. Remember, youre investing for you, and not for the rest of them. Your gains and losses are ultimately your responsibility.
With that said, there are some good tools at your disposal to help you discern when these red flags do give us a good idea on why we should be using stop losses in the first place and what steps we need to take to put them into practice.
Cheers,
Jonas Elmerraji
by: pee123
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