Trade Safely without Stops

Trade Safely without Stops?

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By: Jay Leavitt Phd Email Article

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I participate in a large investment club. Many of the members have been struggling to preserve their hard earned retirement funds. Almost all have moaned and groaned as soon as the subject changes to stops. Every member is concerned with previous threats to their investment accounts: Desert Storm, Bosnia, 9/11, Too Big to Fail.

Great Stocks?

Many of the members have invested in great stocks only to watch their value decline: Enron, Citibank, General Motors, General Electric, Cisco, AIG, Lehman Brothers, Filenes Basement, SGI, Bennigans Restaurants, Six Flags. The list is nearly endless.

What caused The Collapse?

The reasons why a stock falls in price are similarly endless: The CEO just sold 150,000 shares; A reasonable forecast was met yet, the stock price crashed; The SEC has subpoenaed the CFO; Consumer confidence is down; Paid a nice dividend, but the price fell even further; Record earnings and the stock still fell.

Everyone appears to hate protective stops and with good reason: I was the only trade at that price; I had a 10% stop-loss, but I was closed out with a 20% loss; If I had a 10% Trailing Stop, I would been closed out too soon, if the stop was at 20% I would sacrifice too much profit.

No Need for Stops

Both SSO and SDS are leveraged 2:1. If there were a justification for stops, this test would be the proof. The test ran from September 2007 through January 2010, starting during the time period when SSO and SDS first became available. There were almost 79% winning trades with an Average Annual Rate of Return [ARR] over 34%. Next, I ran comparable tests on the Nasdaq 100, Mid Cap 400, and Russell 2000, still using the SPXTimer. The largest losing trade for any of them was 21.64%. Each had over 70% winning trades and even higher ARRs. No optimizing was done to the SPXTimer.

On May 6, 2010 the DJ Industrials plummeted 1000 points in under 1 hour. Any Stops you had in place that day would have been executed. The price you would have received would have been far beneath your Stop price. Later the same day, the market rebounded. You would have fared better without Stops.

No wonder why the members growl!

There is a huge difference between trading stocks and broad based indexes. Clearly, it is possible to make much more money with stocks; but, you can also lose more. How many of you have lost money after listening to Cramer or following the tips in a newsletter? How many of you have lost money after buying a stock you believed could not drop any further?

When it comes to investing, singles are easier than home runs -- and they can end up being more profitable. I am referring to broad based indexes. The S&P 500 is an index, obviously of 500 stocks; the Russell 2000 follows 2000. If the CEO of one of their stocks was indited, it would hardly make a ripple in the price of the index. I am not suggesting the price of an index will not fall if there is bad news. But, trading these indexes is the first step toward minimizing risk.