When I was first considering investing in the stock market, one of the things that struck me was that some stocks seemed to chug along relatively steadily, while others rose and fell like some kind of Fear Factor Ultimate Challenge roller coaster ride. I was looking to make money, not lose sleep, so I was quite happy to forego the highs and lows of certain stocks for the steady-eddies that just kept on keeping on. As a happy coincidence, dividend stocks, which I was investigating at the time, are much more the former than the latter. As my stock research became more focused on the types of stocks that paid stead dividends, I ran across fewer and fewer high flyers. Still, I wondered, is there a way to quantify the volatility of a stock?
The answer is yes, and the number that name that is given to the describing of this characteristic is beta.
I recently wrote about stop orders. Briefly, they allow an investor to set a threshold that, should the market price for stocks he owns reach that threshold, his stocks will be sold into the market, even if the investor is not watching the markets at that particular moment. This post is about another tool in a similar vein that investors should be aware of. It can be used to ride a stock on its way up, and then to sell that same stock close to its top. At worst, a trailing stop helps you cut your losses. At best, it lets you automate the process of getting out while you’re ahead.
The general philosophy of most dividend investors is that once a quality company is bought, it should be held for years, decades, or, as Buffet has famously said, forever. (Notice that forever is his favourite holding period. He didn’t say that he never sells; occasionally, circumstances dictate that stocks should be sold.)
Market gyrations are part of the game, but occasionally, market or personal circumstances may dictate that you don’t want to wait out a price recovery after a drop. The best way to dodge that bullet is to sell before the stock price falls too far.
Unlike Buffet, I am not a professional investor. I don’t spend my life devoted to evaluating companies and making decisions based on my own unique insight. I also can’t spend hours per day watching, analysing, and dissecting the markets. Even so, there are times when I start to ask myself if it’s time to get out of the pool. Many investors, whether to take advantage of a recent run-up, or in anticipation of a potential precipitous drop, wonder if they should sell. For most of us, this kind of uncertainty isn’t a lot of fun. If, like me, you don’t watch the markets closely, a lot can happen while you’re away. By the time you realize that your fears of a price fall have come to pass, it’s often too late. The good news (and the point of this article) is that there is a way to automate the selling of shares before they fall too far, even if you’re not glued to your computer all day.