Question: Could you explain how and more importantly, when to use stop orders?

A BuyandHolder

Answer:

Dear BuyandHolder,

First, let's define stop orders for those who are unfamiliar with them. Then we'll look at three possible scenarios.

A stop order is an order to buy (or sell) if a stock trades at a certain price. Should the stock reach this price, your order is automatically triggered and becomes an order to buy (or sell) "at the market."

In other words, a stop order provides protection against the unexpected. In effect, it says you will not participate above or below a certain price.

(1) If you want to protect your gain...

Let's say, for example, that you bought 100 shares of Company ABC six months ago at $50 per share and it's now at $75. You want to protect that profit so you set a stop order to sell at $60. Then, should your stock fall in price, you know that your broker will sell you out at $60.

(2) If you're uncertain about a stock...

Here's another example. You made a fast decision to buy 100 shares of Company XYZ at $50, in hopes of a quick gain. However, since then you've become a bit queasy about the market. In order to protect your position, you enter a stop order to sell at $47 3/8. If XYZ drops to $47 3/8, your stop order becomes a market order and you have limited your loss to 2 5/8 points per share.

(3) If you're going to be out of touch...

Some investors use stop orders to protect their positions while they are away for long periods of time and not in constant communication with their broker. They may be on an outward bound type experience, on a white water rafting trip, or on a retreat of some sort. In some cases, investors set up stop orders before entering a hospital or prior to starting a serious medical treatment.

For example, you bought 100 shares of a stock a year ago at $42 and it's now at $55. You want to protect this profit while you're trekking up Mount McKinley and so prior to leaving home, you give your broker an order to sell at $51, good until canceled. If the market declines while you're on your hike and the sale is made, you have protected most of your gain.

Determining a percentage...

Investors who regularly use stop orders generally set their targets at 10% below cost or below the recent high or 15% above cost. Of course, there are many variations on this.

Stop orders are not available at BUYandHOLD.

Good luck!