Capital Preservation is Essential for Successful Investing

This is the premise from which I draw the following conclusion:  Use stop losses to protect your capital and gains!  

Listen… it’s just that I hate to lose money.  Furthermore, I’m a weekend investor who doesn’t have time to sit in front of the computer screen for hours at a time, making daily decisions on stocks.  So what can you do to prevent the 9% in a day drop?  Sometimes nothing when it gaps down, but this is a rare case.  Usually, the stock will drop from $10.00 to $9.95, then $9.85, then $9.70, etc. with fluctuations.  And if your return home from a hard day at work to discover you lost more in your investment than you made at your job, you’ll feel utterly defeated.  Extend that a week for those who only want to spend 15-30 minutes a week “reviewing” their portfolio and you’ve to a recipe for disaster if you don’t have stop loss orders in place.  So, I shared with you the following principles in this article:

Remember to look at the overall market momentum
Widen or narrow your stop loss orders based on the overall market momentum
Avoid using an arbitrary stop loss point based on a price or percentage
Use multiple technical indicators
Beware of setting your stop loss orders too tight
As your profits rise, so should your stop loss orders
Now, let’s take a look at a real example from one of my recent trades….
We’re going to look at Royal Bank (RY.TO or RY).  I bought this stock in early September as momentum shifted up.  This is a solid Canadian bank (without the problems of the US banks) that pays a healthy dividend (for all you dividend lovers).  Basically, I wasn’t afraid of sudden news that would drive the stock down, but it still fluctuates like most stocks.  So, I made a purchase at $51.55 in early September. 

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As soon as you make a purchase based on a momentum shift, you’re looking for that momentum to continue within the first 3 days.  If it doesn’t, I bring my stop loss up tight, assuming I’m perhaps wrong.  In this case, 3 days later, RY.TO was up to $52.42 or 1.7% increase.  I’d prefer 1% per day or 3% total after the first three days, but, day 3 was a down day.  So, how do I determine my stop loss at this point?
Here’s a few thoughts… 

Market momentum was shifting up
I realize I have to be willing to lose a little, but I hate to lose money… so I know mine will be tight.
I look at the last 5-10 times the stock dropped… and look at the range from the day’s high to low.  For the previous past 10 down days, RY.TO never dropped more than 1.7%.  So, I know it is relatively safe to have a 2.7% stop loss (which would mean it goes almost down 50% more than usual before I get stopped out and overall, I’d only be down 1%).  I don’t set an arbitrary stop loss order at a fixed price/percentage… I figure out what would be best for the individual stock.
The multiple indicators are still pointing up
Knowing this particular stock, I’d be willing to bump the range up a little 

So, I initially set it at 3% on the first day.

As the stock rises, I split my stop loss order into two parts.  I have 1/2 of my shares on a tighter stop and I widen the stop loss order on the other 1/2 of my shares.  This allows me to protect my gains without cutting off my potential for significant increases (the 60%+ I currently have in AC.B.TO and AGU.TO).  So, within a few days, it’s up 5.7% and so I split my stop loss order (still at 3%).  The other half, I reduce to my purchase price.  Now, if the stock drops 10% in a day, I guarantee myself a 1.5% profit… not great yet, but that’s ok.  A win is a win… but let’s see what happens.

By September 23rd, it isn’t looking great… my first stop loss is triggered.  I’m out of half at a 2.7% profit. Fortunately, the following day, it runs up again for another 3-4 weeks.  As it does, I widen my loss order and begin to use the other technicals to confirm my trade.  I personally don’t want it to touch that line I drew… after all, this is beyond my technicals.  So, unless I’m trading on a weekly chart, which in this example I’m not, I’ll place my stop loss order at $55.50 for a 7.7% gain. 

The total win on that trade is 5.2% – all with a great deal of safety… all with potential to be 50%+.  But when the momentum shifts, I get out and put my money in my pocket.

Well… I’m interested to know if that confused you or helped you understand how I apply these principles with this real life example.  I’d appreciate your thoughts!