Today, I had to make a decision. One of my stocks jumped 11% today, and I'm currently up 92% on this particular holding. But the net value of this company is actually worth four times more in its share price than I paid for it, and I'm looking for a 400% return over the next year or so if I hang onto it. So do I take the money and run, or do I wait for the stock price to climb even higher on its current momentum?
Many people are afraid to invest in individual stock holdings because they're afraid of losing their money, but a Stop-Loss order can help to protect your investment. It's usually a good idea after you've purchased a stock to set up a Stop-Loss order at 20% below the current market price. That way, if the share price drops unexpectedly on a bad bet, you'll only lose 20% of your original investment when you bail out. And you can put the remaining amount of your investment cash to better use someplace else.
A Stop-Loss order can also be used to help protect your capital gains. As the price of the stock continues to climb in the market, it's a good idea to set your Stop-Loss about 20% below the current asking price, and possibly far above what you originally paid for it. This ensures that you'll be selling the stock somewhere near the top after the share price has peaked rather than missing the boat because you weren't paying any attention to your stock portfolio that week. But as long as the stock keeps rising in price, there's no reason to sell it just yet, especially in a recovering economy. Just keep moving the Stop-Loss point regularly to protect your increasing capital gains.
A Stop-Loss order isn't free, but you're only charged for the order once the Stop-Loss activates the sale of your stock holding. So you can set up many different Stop-Loss points over the holding time of your stock, and only be charged for one Stop-Loss order in the end, or possibly none if you decide to sell the stock and cancel any Stop-Loss order that was placed on it.
So I decided to hold onto that stock and I put a Stop-Loss order on it today at 20% below the current market price. That ensures that I will at least get a 70% return on my original cash investment if the share price suddenly drops, and I can be very content with that rate of return.
Update On Apr 09, 2010: I just had to update this article with the latest news on my high-rising stock holding. What was declared by the Wall Street Journal to be the biggest percentage price gainer as of April 7 is also the biggest percentage price loser as of today. But I was able to preserve my 70% capital gain during this short squeeze by using the stop-loss order and selling out when the stock price was on the decline. I hoped for the best, but I prepared for the worst, and that's how I came out ahead in the end.