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Author: scrubbo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 25834  
Subject: Re: Ebay buyer and new stockholder Date: 3/9/1999 1:01 AM
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Great post BrotherBlood.

I thought I'd share with you Fools an actual "formula" that I use for stops on High-Growth stocks. (They are high-growth if I say they are. How's that for despotism? Basically, it means I think that the COMPANY (NOT the stock) is going to be worth a lot more than it is right now, which will bring the stock up. Sometimes the stock rises kicking and screaming, and sometimes the stock roars ahead of the company.)

Not alot gets said about stop orders because a lot of the Fools around here do LTBH (Long Term Buy and Hold) so they wouldn't sell even if the stock tanked unless they thought the COMPANY had tanked. Sometimes it's hard to remember the difference between stocks and their companies. Day traders live on the difference. If stocks were exact representations of companies, we wouldn't see them bounce around like they are wont to do. (Especially not like eBay.)

So the stop method I use is to do a stop senario like this :

When the stock hits 250% (a gain of 150%) of my buy in price, I set a stop for half of my shares at 200% of my buy in price. This will take my entire initial investment (minus fees) out of the stock and whatever is left over is profit. If the stock completely tanks, I'm only a few dollars poorer, when it goes down and starts climbing again, I can re-purchase the shares if I'd like, (usually losing a little money if I rebuy when I'm sure the drop has turned around because the stock is now back up to 200-210% of my original buy in price) or socking them into a more stable company (WAG is my standard "safe" company).

If the stock never brushes 200%, but hits 350%, I set a stop for 1/3 of my stock at 300%

Again, 450% gets 1/4 stopped at 400%.

And so forth and so on

If it ever hits 600%, I consider selling 1/6 and never bothering to worry about the stock again, or even not selling 1/6 and just not worrying about the stock. It's got a great liklihood of being a winner for a long time. If it's a short term 600% jump, I'd sell the 1/6 w/o blinking (short term like 2-5 years depending on company) and sock it into my latest pick. If it took longer than that, I'd just leave it alone because it's probably had an easier time filling in. (getting the companies actual value closer to the stock's price)

Once I have pulled my initial investment out of the company, I never set a stop again. (What never? No never! What never? Well.... hardly ever!) I let it run, fall, fly, stumble, and basically frolic about however it wants. It's now a hold until I die or I feel the COMPANY has ceased to be worth owing a part of.

This is a technique that I inherited and modified to suit my own needs from my Mom, who started investing for me when I was 5. She beat the market averages over the 23 years she invested for me by looking for good companies with stocks that were beaten down, and always setting up a "get your money out" scenario on stocks that weren't so blue chip.

So far I haven't had a stop order sell on my stocks that I have picked, (Ebay hasn't gotten to 250% of my buy-in, so it's got no stop order. I never buy a stock I'll be stopping at 100% after reaching 150%. If I don't think it'll eventually grow from the price at which I'm buying, why buy it?) but I suspect that when and if I get my eBay stop set, eBay will eventually trip it because of it's volatility. 50% is a HUGE run most of the time, but not for eBay, and consequently if the stock doesn't settle down, it'll trip my stop. (I'm betting on the 1/3 sold at 300%) And as the numbers get higher, the drop from 350% of buy-in to 300% of my buy in price constitues a 14.2% percent drop in stock price. It becomes more pronounced from 450 - 400, and 550 - 500.

Here are some fake numbers to demo the changes :
Buy in price : 100 a share

Price reaches 250 a share (250% price, 150% gain),
Stop placed at 200.
Stock must now drop 25% to be sold.

Price reaches 350 a share (350% price, 250% gain),
Stop placed at 300.
Stock must now drop 14.2% to be sold.

Price reaches 450 a share (450% price, 350% gain),
Stop placed at 400 a share.
Stock must now drop 11.1% to be sold.

Price reaches 550 a share (550% price, 450% gain),
Stop placed at 500 a share.
Stock must now drop 9.1% to be sold.

Price reaches 650 a share (650% price, 550% gain),
Stop placed at 600 a share.
Stock must now drop 7.7% to be sold.

So my "mechanical" method of setting the stock stops eventually pulls my initial investment out of the stock and frees it up for other uses, leaving me pure profit in the stock. Because even the best stocks will drop 7.7% from their highs. Heck, 14.2% off of high for a growth stock isn't unreasonable. Eventually I will pull the money out, and the higher a stock gets, the more likely I am to pull out my initial investment.

I only use this on high-growth stocks that I plan on keeping (really the only kind I'm comfortable buying besides blue-chips), so this isn't the kind of stategy I'd be using if I were trying to day/week/month trade the same stock. It just gives me a good way to keep tabs on my stock w/o worrying about them all the time, and when my money does get pulled out, I'm happy cause I have a pure profit stock (my Mom calls them Free Stock, like a present from Santa) and I have a chunk of change to put in my favorite holding stock, or to invest in whatever I think might do well.

Now, there are arguments both for and against selling your "winners", and I agree mainly with the not selling your winners, which is why I weighted my auto-pullout method to favor letting the stock run as long as it can maintain a high growth curve (and is eBay ever doing that!) but it does cut down on my returns by pulling money out of a "winner." However, if it ever does pull the money out and the stock tanks, I'm no worse of for wear. And if the stock tanks before getting to 250% my purchase price, I live and learn with my mistake. (Not to say I wouldn't sell a company OBVIOUSLY about to get nuked, but I probably wouldn't sell one that dropped and sat an nowhere for a few years until it was obvious it wasn't coming back.)

I wouldn't use this method on a stock I think was going to go up for awhile and then drop.

I wouldn't use this method on a blue-chip company, like MSFT, monsters on the DJIA, and others in that ball park.

Will I use it on eBay? Probably. I'm very bullish on eBay, but I have little cash in my accounts, and eBay is in the category of a high-growth stock. Will I loose a little money? Probably. Will I buy some peace of mind? Definately. Should everybody use this technique? No. Should ANYBODY use this technique? Sure, if you like fast stocks but get a case of the nerves from time to time. I use it because it's easy to figure out, and a similar technique has worked for years for my Mom, and because I LIKE the concept of Free Stock. And the method is easy to adjust (putting a bigger range inbetween the when I set and where I set prices (say 180-100, 280-200 if you want to allow for higher volatility) and how often I set the stop orders. (Why not 150-100, 200-150, 250-200 etc if you want a little finer control) The higher a stock runs, the more nervous I get. But with a stop-order scheme running, I'm not nervous. I own eBay and don't worry about a thing. I watch the company, and as long as it's being the kind of company I want to invest in, I'll own stock. Eventually I'll sell of a bit to recoup my initial investment, and suffer a bit of loss on growth because of it, but I'll NEVER worry about it.

I've been watching my stocks like a hawk, and it doesn't help them one little tiny bit. Once you've picked them, staring at the pricetag doesn't help. So having a stategy helps me not panic at a huge leap in price, or a big slide, or anything like that. I've got a plan by golly! It feels good, too.

Anyway, that's my spin on stops. Now ask about limits! And using a stop limit! The tools of the active trader! That's not me. Me, I'm just a big windbag nervous nellie who likes tech stuff (stocks and toys.)

Fool on!

Scrubbo
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