Stop-Loss Can Brake Fall Orders Help Investors Set Exit Strategy In Jumpy Market

Would you go up in an elevator that had nothing to brake its fall if the cable snapped?

Not many people would. But lots of investors keep riding their soaring stocks with no plan to avoid a crash like Friday’s if things go wrong. With the market especially pricey and volatile, it’s a good time to decide when you’re going to get out.

“The hardest thing to do in our business is to decide when to sell,” said William Banks, manager of Advest Inc.’s branch in Marlton, Pa.

To protect his customers’ gains, Banks uses stop-loss orders to automatically dump stocks when they fall to prices he sets with the help of a technical charting system. The stop price is adjusted frequently as the stock moves up or down.

“I spend a good deal of time on my accounts dealing with stop-loss orders,” he says, adding that one customer has 70 such orders in place.

With a stop-loss order, an investor tells his broker to sell a stock if the price drops to a set level. The order is sent to the exchange and automatically executed after the stock trades at the stop price.

In most stop-loss orders, the sale is conducted at the market price, which might be lower than the stop price - $17 a share when the trigger was $17.50, for example. You can avoid this by using a stop-loss limit order, which specifies that your stock won’t be sold below a set price, but you risk greater losses if the market skips the limit price on the way down. Orders executed automatically:

In most cases, investors have a pretty good chance of selling near the stop-loss price anyway. Execution is automatic, and it’s done on a first-come, first-served basis, so the stop-loss order already in the computer will be executed ahead of the regular sell orders that might flood in during a panic.

How do you determine a stop price? Banks uses a technical analysis known as a point-and-figure chart. This is a way of recording a stock’s up-and-down moves with X’s and O’s on a graph, identifying trends. The results are compared with studies of how stocks have behaved in the past, on the theory that certain patterns often are repeated.

For instance, a stock that has hit a peak, dropped lower, then recovered and gone above the previous peak is said to have a “double top,” and a high probability of rising more. A “double bottom” is just the opposite: a signal the stock is headed lower.

Using this system, Banks Wednesday set a stop price of $17.50 for Maytag, a stock he recommended to his customers in January at $19 and was trading Friday at $20.50.

The bible on the subject is “Point and Figure Charting” by Thomas J. Dorsey (John Wiley & Sons).

Another way to establish a stop price is to chart a stock’s moving average, - its average price, updated daily, over the last 150 or 200 days, or for some other period. This produces a graph that evens out the daily ups and downs to reveal the long-term price trend.

A stock on the upswing trades in the present at prices above the moving average. Banks sets the stop price at the moving average or slightly below, so he can bail out when the stock crosses the line on its way down. Maytag’s 150- and 200-day averages are $18.75 and $18.00.

You can chart moving averages yourself or use a source such as Value Line, which is carried in many libraries. Some online systems also chart moving averages.

In using technical approaches, keep in mind that they are not the be-all and end-all, just a way to gain more insight and impose some discipline on yourself.

“The goal is to remove the emotionalism from the decision-making process,” Banks says. You still need fundamental analysis to determine if an investment prospect is a financially strong, well-run company with a promising future, he says.

But once you’ve decided “what” stocks you want to own, the technical tools can help determine “when” to buy, he said.

And, as important, when to sell.