Protecting Stock Profits: A Step Beyond “Buy and Hold”

(originally published Sunday, May 1, 2011 at www.TheRightHuff.blogspot.com)

Life is a process. And so is investing.

You’re a smart person. You earned some money which is now investable. (Praise God for capitalism!) You understand that investing in stocks can help your money grow over the long-term. But there’s a learning curve, and you can’t skip over it just because you’re intelligent.

Surprisingly, the learning curve of investing in the stock market is not about being smart; it’s about getting a grip on your emotions and being brave enough to follow through with a strategy, even when you are getting scared or greedy.

I’ll tell you right now that folks who are easily angered, or who worry constantly, are not going to fare well in the stock market, so this conversation is aimed at people in between. We are emotional creatures. If the police officer pulls you over, and you can handle yourself without showing anger or crying, you can probably handle the stock market fairly well. (p.s. If the police officer pulls you over, and you’re busy hiding contraband and gulping breath mints, you’ve got bigger problems than losing all your money in the stock market!)

You already understand the concept of “buy and hold” investing. How can we improve upon that? Here’s what I have been doing recently with my own stocks.

First of all, many stocks go up and down in trading ranges, which you can identify by looking at their stock price charts. Most of the stocks I buy are in these trading ranges. When I buy them, I almost always simultaneously put in a sell order on the high side of the trading range.

Look at the long-term chart on Home Depot (HD, $37.15). The price is recovering from the 2008 financial meltdown. Do you see where the stock traded steadily up and down, from $33 to $43, for four years leading up to 2008? Then the price crashed, and then it began its recovery. To me, it looks like it’s about to re-establish that $33-$43 trading range. Home Depot is on my short list of stocks which I might buy next, and I won’t wait for it to drop to $33. I’m not greedy. If I buy at $36 and sell at $42, minus commissions, that’s about a 14% profit. It formerly took Home Depot stock about 2.5 to 5 months to make that price move. Personally, I’d be happy to make 14% in 5 months. What are the banks paying right now? Less than 1% for the full year?!

My goal is not to measure my stock performance vs. Jim Cramer or Warren Buffet. My goal is to make investment returns which outperform safer alternatives, while finding ways to minimize risk.

Other stocks which I own are climbing back up towards previous highs, or “resistance levels”. I bought Kraft (KFT) at $31.40 and I have a sell limit order at $34.00, and I bought Sanofi-Aventis (SNY) at $34.97 and I have a sell limit order at $40.00.

And then there are stocks which are freely climbing. I don’t want to pick an arbitrary sell price, and miss out on 25% of my potential gain. On these stocks, I put in a stop loss order, which means that if the stock finally starts to fall in price, it will automatically sell if it hits the stop price. Right now I own WellPoint (WLP) at $66.37, the stock price is $76.79, and my stop loss order is at $73.00. Each day that the stock rises, I raise the stop loss price. I can do this with my online brokerage account at Morgan Stanley, and it doesn’t cost me anything extra to use and change stop loss orders vs. selling the stock outright. If WellPoint reaches $82, I will cancel the stop loss order and sell the stock at that price, because that’s near the top of a pre-financial meltdown trading range. And if WellPoint stock falls tomorrow and sells at $73.00, I will have net profit of 7.8% in 66 days, plus a little more from dividends. I’ll take it!

Why wouldn’t I expect WellPoint to keep climbing through the mid-$80’s? There are a lot of people who bought this stock several years ago around $80, and they’ve been holding onto it and grimacing for up to six years now. They are desperate to sell and break even. As the stock price reaches their cost basis, they will be selling, which will drive the stock price back down repeatedly until all those folks are done selling.

Finally, there are stocks which I own which are disappointing me. I bought Fifth Third Bancorp a while back, and the trading range fell. So I put in a sell order at the top of the new trading range and got out with a small loss, about 2%. I’m not interested in waiting for the stock to stabilize in this new trading range before finally climbing back to the trading range where I bought it. During that time, my money can be better invested in a stock which has current momentum.

To be a successful stock investor, you will need to learn to face the horror: stocks which are falling in price. I know my stock’s trading range before I buy, and then if the stock falls through the bottom of that range, I usually sell, unless there’s a huge dividend, such as 5.7% on Altria (MO). With a stock like that, you’re getting paid to wait. Plus, people don’t usually panic and sell a stock that’s paying them 5% per year, so it becomes less likely that the stock price will go into a freefall.

If I have several stocks which are selling at the tops of their trading ranges all within a few short weeks — as I have had during these last two weeks in April 2011 — this indicates to me that the market is toppy and is due for a short-term correction. Therefore, I hold onto the cash, make a list of stocks I’d be happy to own at certain prices, and wait for the market to correct.

If it’s just one stock selling here and there, I reinvest the money right away into another stock.

Happy investing!

Crista Huff

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