Last weekend, I wrote a little about what I consider to be the
importance of vacations. In this article, I'll look at some things we
can do about our trading when we do take a vacation. There are a few
choices:
1. We could go on vacation and ignore our portfolio completely. This
alternative is not for me. The pure "buy and hold" investor may be
content to just let it ride, but I do not want to be caught in a
downdraft if I can help it. With my luck (and probably yours), the day
I take off with a number of unprotected bullish positions will be the
day the market crashes. I'm all too aware that a 50% drop in a stock or
my portfolio requires a 100% move up to get back to even.
2. We could close all our positions. While not my personal choice, this
may be a viable alternative. If we close all positions we could miss
out on dividends or favorable moves. However, we would be in cash so we
would not have to worry about a drop in portfolio value.
3. We could place orders that would put our portfolio on auto-pilot.
For example, if we owned stock, we could buy some protective puts with
an expiration sometime after our return from vacation. Buying
protective puts means that we could exercise the put and force the sale
of our stock at the strike price of the put anytime before the put
expired no matter how low the price of our stock may have dropped during
our absence.
Some brokers (my internet broker included) permit the
entry of trailing stops. Let's say we bought a stock for $20 a share.
A trailing stop moves in the direction of your play so it has the
advantage of initially reducing risk and ultimately protecting profit if
the price of the stock goes up. If the stock price falls, when hit, the
trailing stop will take you out of the play. In our $20 stock, we could
decide that it should be sold if it drops 50 cents so we could place a
50 cent trailing stop. Initially, with the 50 cent trailing stop and
the stock at $20, our stock would automatically be sold if the price
dipped to $19.50, but suppose the stock price moved up to $20.75. Now,
our stop would be at $20.25 so we would be sold out if the stock dipped
back to $20.25. If the stock dipped to $20.30, our trailing stop would
still be at $20.25. Once at a specific level, the stop would never go
down unless we changed it. If the stock went to $30, our trailing stop
would move to $29.50 etc., etc.
One may also use a percentage trailing
stop instead of a specific dollar amount and achieve a similar result.
One downside of stops or trailing stops occurs if the stock gaps against
you. In the earlier example, suppose the stock had been trading at $25.
Our 50 cent trailing stop would be activated if the stock went to $24.50
or below. Suppose the stock gapped down to $18. In that situation, the
stop would be activated at the $18 and our stock sold at around that price.
Now we see that there are at least a couple of things we may
consider if we want to ignore our positions for some period. We could
buy protective puts to reduce risk or we might consider placing a stop
loss order or a trailing stop loss order. In the next article, I'll
discuss some slightly more complex orders that can be used to accomplish
even more with the portfolio while the trader is absent.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
