Saturday, December 08, 2007

Biting the bullet

MARKET READER: Biting the bullet

BY: Den Somera

The expression "biting the bullet" is an idiomatic phrase meaning to enter with resignation upon a difficult or distressing course of action.

The expression is also used in the stock market to mean folding a losing position.

The Hunt

Incidentally, many investors find biting the bullet hard to learn even after being in the market for some time.

For them, biting the bullet is like drinking the farewell cup that results into one's own death. It evokes horror and a feeling of regret similar to the testimonies of people on the verge of death.

Speaking from experience, cutting losses is really difficult. One loses self-respect. It makes him feel less not only materially but psychologically as well. And for that alone, cutting losses is an act difficult to follow. That's why many actually don't seem to learn how to cut losses and, worse, don't know when to do it. Sometimes, they feel they should have done it earlier, before they became totally broke.

More successful stock traders and investors say the emotional and psychological trauma of cutting losses in a losing position can be avoided by using some mechanical tools.

Some price triggers are all that is needed to make stock trading more mechanical than mental. This is by the use of so-called protective "stop orders."

Secrets of the past

Stop orders are really needed when trading in the stock market. It's a common experience that when the market goes against one's trade, critical judgment is weakened and false hopes rule. Some investors even paradoxically go into risky gambles to avoid taking certain losses.

The first of these protective stops is the stop order. It's an order to buy or sell a stock when its price reaches a particular level.

This ensures a particular entry or sell price. It also limits the investor's loss and locks his profits.

This stop order is also referred to as the stop-loss order. Professional traders use this type of stop order to protect their position when going on an extended vacation, during which they cannot watch the progress of the market and their stock positions.

Another type of stop order is the stop-limit order. It's an order placed to buy or sell at a specified price after a given stop price is reached or passed.

The limit price is the trigger to execute the order. This stop order is effective and applicable when buying a stock that is going up.

The most interesting stop order is the scale order. It's a type of trading order that comprises several limit orders at incrementally increasing or decreasing prices.

Like in the scale order to buy, the limit orders will decrease in price, triggering buys at lower prices as the price starts to fall.

With a sell order, the limit orders will increase in price, allowing the investor to take advantage of increasing prices, thereby locking in higher returns.

To illustrate, if the investor wants to purchase 100,000 shares of stocks, he may scale the limit orders so that 1,000 shares are bought for every P100 fall in price.

There is also the limit order. This is an order to buy or sell at a predetermined amount of shares at a specified price or better. The limit order may also limit the time an order can be outstanding before being canceled.

Limit orders typically cost more but are beneficial because when the trade goes through, the investor gets the specified purchase or sell price. In practice, limit orders are useful during low volume of highly volatile stocks.

The most popular among the stop orders is the buy stop order. It's a price above the current going price. The buy stop order starts to work when the price exceeds the price the investor has set.

In that event, the buy stop will automatically trigger a market order. The buy stop is particularly applicable when the investor correctly anticipates a rise in stock price.

The reverse of the buy stop order is the stop loss order. The principle is the same except that instead of watching out for prices on the uptrend, the point of trigger is when prices start to go down.

Lastly, when a stock price decreases and, consequently, an investor's stop order is executed, one is said to have been stopped out. In other words, when you place a stop loss order to sell when the price of the stock moves below P50 per share, and it does, you are said to have been stopped out.

Insider lies

Corollary to the stop order is the concept of averaging down and averaging up. The former is buying stocks at prices lower than previous buys. Averaging up is the opposite, where one buys as the price of the stock goes up.

In the former, you get more shares for every peso spent, while in the latter, you buy fewer shares for every peso spent.

Averaging up is said to be the better trading strategy since of the four cardinal rules in risk management in stock investing, the first is to never average down.

So what are the ideal stop prices? They are usually the prices found just below major moving averages, trend lines, swing highs, swing lows or other key support or resistance levels.

(The article has been prepared for general circulation to the reading public and must not be construed as an offer to buy or sell any securities or financial instruments referred here or otherwise. Moreover, the public should be aware that the writer or any investing parties mentioned in the column may have a conflict of interest that can affect the objectivity of their reported investment activity. You may reach the Market Reader at

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