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Archive for May, 2010

Investment Term Of The Day: Preservation Of Capital

Preservation Of Capital: An approach whereby one adopts defensive stance towards maintaining / keeping the value of the capital to minimize adverse effect on the total value of the capital.

Market Condition / Direction

“A Turtle never tries to predict market direction but instead looks for indications that a market is in a particular state. This is an important concept. Good traders don’t try to predict what the market will do; instead they look at the indications of what the market is doing”

– from Book “Way of The Turtle”

Setting Stop-Limit (Stoploss / Trailing Stop) Orders

Okay, assuming that you have done your research, timed your entry accordingly and bought a stock that you think is going to rise both in the near and long term.

To either manage your risk or to protect your profit, you could set a Sell-Stop-Limit order, which essentially consist of 2 parts. One is the “Stop Price” and the other is the “Limit Price”.

“Stop Price” – the price of the underlying shares, when reached, your trade order will be triggered.

“Limit Price” – the price in which your trade will be at the set price or better. The Limit Price has to be lower than your Stop Price.

Caution:   If you set your Limit Price too close to your Stop Price, in a fast moving / or thinly traded market,  your order may not be executed. If your intention is to get out, regardless of price level, it is good to leave some room between the Limit Price and the Stop Price.

Examples:

Setting Stop Limit As A Stoploss Order

You bought Apple Computer shares at USD250/share.

Basing on the chart and your risk appetite, you are willing to risk only, say 8% of your position, which works out to be USD230/share. Hence, you set your stop price to be at USD230/share and your limit price to be at USD228/share. When that is set, should Apple Computer’s share price hit USD230/share, your order is activated, and your order would be filled at USD228/ share or better.

Setting Stop Limit As Trailing Stop Order

Same initial scenario: You bought Apple Computer shares at USD250/ share.

Now, your Apple Computer shares has moved to USD280/share. Say you are willing to give up 50% of your gain (50% * [280 – 250] = 15, 250 + 15 = USD265/share) or using another number that you determined using say a 50 days moving average, to continue to stay in the position. So, you set your stop price to be at USD265/share. Say, you are putting up a tight limit price because you feel that Apple Computer has enough liquidity and think that you should be able to get out pretty quickly. So, you set your limit price to be say, USD264/share.

So, should Apple Computer’s share price weaken and hit USD265/ share, your Stop Price will be activated and if things go as planned, your position will be sold out and you collect your profit of about USD14-15/share.

Here’s the important part:

Should the stock continue to move up to even higher level than USD280/share level, you should consider slowly move both your Stop Price and Limit Price up basing on the rule that you set for the position. By doing so, you allow the share price to move up, with some room for fluctuation and yet be ready to get out when there is any adverse price movement. This is what we call a moving Trailing Stop.


Note: The above explanation is for education only and could be specific to certain trading platform and meant for education purpose only. If you are unsure, please refer to your broker / service provider to better understand the function provided in the trading platform.



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