Trailing stop losses are one of the most important investing techniques investors can bring to bear against a fluctuating market, yet they often go ignored.

That’s probably because using them is a form of daily torture. The time spent calculating them by hand is better spent looking for new investments.

But let’s back up a moment…

Trailing stops are the stop loss orders you set for one of your long stock positions at some percentage below its trading price. You’ll see us commonly use 25% as our trailing stop percentage.

It’s easier to visualize the process with an example:

Let’s pretend we bought shares of drug maker Dynavax Technologies (DVAX: NASDAQ) on January 18, 2007. That day, we were able to buy shares at $6.07 each. The stock had a nice little run for the next several trading sessions. A few days later on January 22, DVAX closed at $6.20. That’s an important number since that’s the highest closing price the stock has had since that date. For every trading day since, those closing prices for the stock have been lower than $6.20, and on March 5, 2007 the stock closed at $4.56. That’s the first day since we bought the stock that the closing price has been 25% or more lower than the high of $6.20 during our holding period. If this weren’t hypothetical, that would have been our trigger to sell all of our shares of Dynavax.

Source: BigCharts.com

This is a pretty cumbersome process, isn’t it?

Well, we have to do it…

The theory is that if we have a portfolio that contains nothing more than a handful of small losses — 25% at most each — and some really big winners, we will ultimately build wealth successfully.

The beauty of the trailing stop is twofold: It cuts your losers off at 25% (or whatever percentage we set it), before they lose 50%, 75% or all of our investment. It’s gigantic losses that can destroy your profits. The other benefit to the strategy is that it lets your winning stocks continue to run higher, hopefully with some gaining 100%, 200% or even more.

And before I go any further, I should tell you that the parent company of Agora Financial does have a financial interest in this site. That was borne out of the fact that the site is such a useful tool and so relevant to our research that we couldn’t resist getting involved.

I was attracted to TradeStops before it was even launched. I met its creator, Richard Smith, at a major investing conference in New Orleans a few years ago. He had been a subscriber to our newsletters for years, but always felt that there was a need for a trailing stop service for our readers. After he showed me a beta version of TradeStops on his laptop, I was convinced that this would be a winning product.

What makes TradeStops a lifesaver for me is that it tracks everything automatically. It monitors all of my Small-Cap Strategy Report and Small-Cap Insider investments and tells me how close or how far they are from the trailing stops I’ve set.

But the best part is how TradeStops notifies me of what’s going on with my stocks. It sends alerts to me through e-mail and my cell phone. You could even set it up to send alerts directly to your full-service broker.

Subscriptions to TradeStops.com range from $69.95-109.95 per year. I think it’s an invaluable tool for my work. If you’d like to try it, there is a 30-day free trial, and I think you’ll quickly be hooked.

If you have an online brokerage account, check to see if it offers a trailing stop alert service similar to TradeStops. If so, I encourage you to use it.

Until next time,
Craig
April 12, 2007

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Investing with Trailing Stops was originally featured in the Penny Sleuth.