Monday, June 22, 2009

How to buy low and sell high - for real!

The number one reason people don't buy low and sell high is emotion.

Emotions cloud our thinking, and make us do things we wouldn't think of doing otherwise. Think of the fall of 2008 into spring 2009 when the market was shedding hundred of points on a daily basis. I know many people who got out of the market altogether because they panicked.

That's why the best thing you can do as an investor is to remove yourself from the moment. Create an action plan for your investments ahead of time and that way you simply become the executor of the plan when conditions demand that action.

The obvious trick to buying low and selling high is knowing which is which. Too many people try to time the market and guess incorrectly - they let their emotions get the better of them.

So, how do you take the emotion out of it, and ensure you don't try market timing?

Know your orders.


The basic tools that allow you to buy and sell stocks without being present in the moment or even at the moment of execution are the Stop Order and Limit Order.

Market orders are real time trades, that are executed at the time they are received, but Stop Orders and Limit Orders are executed only when market conditions reach a trigger threshold.

Stop Order.


A stop order is a market order that is executed once the share price has dropped below a specified threshold set by the seller.

Here's an example:

You have 100 shares of stock in ACME Widgets Inc. and have decided that good times at ACME are about to end. You've decided to sell all shares, but don't want to miss out on any further gains the stock  may make before it starts to drop. It's trading at $57 per share, and you decide that you'd be happy if you sold your shares at $55 per share. Using a market order, you'd have to sit around and watch the stock price all day and hope to sell at the right time.

Alternatively, you could use a stop order and set the execution price at $55, then go fishing (or whatever else you feel like!). If the stock price drops below $55 while the order is in action (usually a day or 60 days), your shares are sold and you reap the reward.

Limit Order.


Now let's suppose that you don't own any shares of ACME Widgets Inc., but you would like to. You think a fair price is $48 and would like to buy 100 shares if the price ever hit that target. Here's where a limit order comes into play. You would issue a limit order for 100 shares of  ACME Widgets Inc. with a target price of $48. If the share price drops to $48 or lower, your order would be executed.

Conclusion.


Both stop orders and limit orders are incredibly useful investing tools, but they don't eliminate all risk. For example, you still have to have your valuations right, and there will be plenty of times when the price will overshoot your targets - in both directions! But the key here is that these tools can help you greatly reduce your losses and even maximize your returns.

Happy investing.

7 comments:

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Matthew Krinner said...

Thank You for sharing your knowledge.

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