Dale Jackson

Personal Finance Columnist, Payback Time

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“Capitulation” is the buzzword of the week as strategists at Sanford C. Bernstein dispute the findings of the latest Bank of America (BofA) global fund manager survey suggesting investors have already done all the selling they’re going to do this downturn.

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If Bernstein is right, equity markets will fall further than the 16 per cent drop for the S&P 500 so far this year. If BofA is right, markets are at (or very near) the bottom.

Either way, capitulation is a buy signal for bargain hunters with cash on hand. And while it is impossible to time the exact moment markets bottom out, there are ways to manage the risk of a false bottom by placing conditional orders on trades that lock in gains as the investment rises in value and limit losses if they plunge.

It’s called a trailing stop-loss; a computer-age take on the traditional stop-loss order.  

A basic stop-loss is a pre-set price below the current price of a stock you own that will trigger a sell order if it falls to that level. For example, if a stock purchased at $10 has a stop-loss placed at $8, losses will be capped at $2 per share.

A trailing-stop automatically resets the stop as the stock rises. In other words, if a stock rises, the trigger to sell automatically moves up in proportion to the real-time price, like a moving stop-loss. In addition to locking in gains, a trailing stop locks in bigger gains as the stock rises.

The real skill with any stop-loss orders is where to set them. If you place them too close to the trading price, they could be triggered by volatility unrelated to the specific security. In addition to losing a potentially lucrative position, investors could rack up unwanted trading fees.

As a general rule, professional traders set stop-loss orders within 10 per cent of the current price and expand them for more volatile stocks that trade on less volume. They often use target prices from analysts who cover the stock, or pick support and resistance levels from technical charts.

Stop-loss strategies vary and are just one tool in an arsenal of conditional orders that give do-it-yourself investors the ability to pre-program their entry and exit strategies.

Investors can also employ opportunistic strategies with buy and sell orders. One strategy for bargain hunters who love a stock but refuse to pay a high price is to pre-set a lower price that they feel is fair through a limit order. 

Another conditional order with as many variations as an investor can dream up is a stop-and-reverse. Most often with that type of order, when a long position reaches a specified stop-loss it is sold and a short position is opened at the same price. It's important for retail investors to be aware that conditional orders are even more vital for short positions, since there's no limit to how much a stock can rise. In such a case, a buy-stop order can limit losses or lock in profit.

Strategies can also be implemented involving partial positions. If a stock doubles, for example, a stop-loss on half the position can preserve the initial investment.

Traders should be aware that in most cases conditional orders expire after 30 days. If you don't keep track, your investments may not be protected. 

It’s also important to know that a stop-loss might trigger below the pre-set price if a low-volume stock is in a free fall. It’s like firing a bullet at a fast moving target.

With most brokerages, the cost of utilizing conditional orders is included in the trading fee, so there is no extra charge for the investor. Many even offer online tutorials on how to effectively use them. 

Some professional investors swear by conditional orders. Some don’t bother with them. It doesn’t matter much if you are glued to your computer screen throughout the trading day; but for do-it-yourself investors dealing with life’s distractions, they can be priceless. 

Payback Time is a weekly column by personal finance columnist Dale Jackson about how to prepare your finances for retirement. Have a question you want answered? Email dalejackson.paybacktime@gmail.com.