Saturday, July 28, 2007

Recent stock market activity

So, have you been spooked by recent blood bath in the stock markets? It's has been like this during the week of July 23 all over the world.

Even with that, stock market has done well so far. Around 8% gain in the US and much more elsewhere.

Remember a bear market is due for sometime now. We have had a great ride since 2002. If we expect bear markets in once in 3-5 years, it is high time now.

So, what can be done to survive the bumpy ride?

If you have a diversified portfolio of passive mutual funds and you believe that stock market is the best route to make money over LONG term, leave your money there and forget about it. It's absolutely foolish to take out money just to avoid future losses. History shows that people who try to time markets end up selling when the market is at its lowest and end up buying when market is at it's highest. Also, once you take out the money, you should find another investment opportunity. Where is it going to come from? You may lose valuable time in scouting for one such opportunity. During that time, stock market may rally as it happened after similar down turn in February.

If you have invested in individual stocks, you should get more prudent and diligent if you are not already. You should remember it is not good to lose too much money on individual stocks. Diversified portfolios will eventually come back. Individual stocks are not guaranteed to be. So, always make sure of how much you are willing to lose on any individual stock. 5% is reasonable. 10% if your stock has been a good stock historically. So, as soon as you buy, set a stop order which 5% or 10% less than the price you bought the stock at.

Second thing is to lock in profits after your stock has appreciated reasonably. One principle that has worked well for me is to use trailing stop order after the stock has appreciated reasonably. My measure of reasonable appreciation is 10%. Once a stock has appreciated 10%, I set a trailing stop with 2%. So, if stock keeps going up, the lowest selling price continues to adjust up and if it starts falling down, trailing stop gets converted to stop order and locks down profits with at least all the profit minus 2% or whatever you have set.

Trailing stop is not a good order to set in the very beginning or when stock has appreciated only a little. If you set it soon after you buy, it will sell of quickly as the price adjusts up only when stock moves up and not down. So, to avoid losses, continue to use stop orders. Only after you are sure to make at least 8% profit that is when stock has appreciated at least 10%, it makes sense to set trailing stop order.

If you can avoid losing too much money on individual stocks, it is easier to make decent money on most of your trades. It is very rare that you will end up losing too much money with stop orders and you are sure to lock in your profits with trailing stop orders.


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