Can you protect your stocks from a falling market automatically?
In the world of investing, protecting profits and limiting losses is tantamount to success. The most common method of protecting your money from downside whether it be to keep profits or limit losses, may be to sell out all or some of your holdings and turn that into cash.
You could have a preset price on percentage in mind, much like going to a casino to play a slot machine and the spouse says you can’t lose more than $200. Although most people exercise good money management at the one armed bandit, far fewer people have this exit point strategy in mind when dealing with their retirement funds.
Is it wise to have an exit strategy?
One only needs to remember how it felt during the 2008/09 market freefall. Thoughts of losing it all put the squeeze on many investors grey matter and more than a few investors and advisors lost some sleep during those dreadful times.
That said, having a predetermined sell point might be a good idea in case of a catastrophic market collapse. No one can say it will or won’t happen of course.
Investors could just keep in the back of their mind a predetermined selling point. Something like if they lose a certain amount or if a stock hits a certain price, you call your broker and tell them to sell. The problem here is you might forget, lose your nerve, change your mind or worse yet, be unable to get through to your broker, which can happen during severe market upheavals.
However there is a way you can enter a sell order automatically on certain types of stocks and funds with some exceptions of course.
A “stop” order can be entered ahead of time by phone, computer or otherwise. These work by keeping your order on file and when the price is hit, the sell order is transmitted to the appropriate people in the market place who then attempt to sell your stock.
This order can be placed usually anytime and at any price you prefer. They work like this:
Suppose you have a stock that is $100 a share today and you decide you want out at $90.00 or lower. You enter your order as a “stop” order (in lieu of a market or limit order) at $90.
That order will sit for a predetermined amount of time, usually 60 days, and if the stock never hits $90 the order expires at the end of the term. If the stock does hit 90 anytime during the timeframe the stop order then becomes a market order. This means when your order hits the trade pits you get the market price for it. This also means you could get less or more than your stop price. In fast moving markets, your stop price, becoming a market order, means you get what they give you when your order hits the front of the line.
Another type of stop order is to add the word “limit” to the above order and enter a “stop limit” order.
The “stop limit “order means you want out at a certain price and will take no less than that price.
Although this sounds like a better way to go, the old adage there are no free lunches comes into play. Suppose you own the same stock at $100 a share and you enter the order under a “stop limit” (versus a stop order) at the same $90 price as before. The stock hits 90 and your order triggers. In this case, your order instructs the market makers to get you $90 but no less.
Should the market be moving fast and because your order again has to wait in line, if the stock keeps dropping, you may not get out. The market makers have their marching orders from you which are “I want $90 and no less”. If the stock hit 90, and your order triggered, but while waiting to get filled the stock kept dropping, if it now is below 90 and because you said you want 90 and no less, you MIGHT NOT get out at all, or only get partially filled.
Summarizing: a “stop” order will certainly get you out but the price you get may be below your stop price. A “stop limit” will get your price but you might not get out at all or only be partially filled.
Keep in mind during the 1000 point flash crash (August 24th, 2015) the drop happened so fast, many stop orders were filled significantly below their stop price. Keep in mind stop-limit and stop orders may not prevent losses and there is no guarantee of being filled under ideal conditions but these types of orders do illustrate some strategies that many investors might not be aware of. Contact your local financial professional for more information on protections strategies that may be available to you.
This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. Mr. Cuniberti is an Investment Advisor Representative through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Marc can be contacted at SMC Wealth Management, 164 Maple St #1, Auburn, CA 95603 (530) 559-1214. SMC and Cambridge are not affiliated. His website is www.moneymanagementradio.com. California Insurance License # OL34249