"Irrational Exuberance"
Has Become Irrational Panic

The "irrational exuberance" that Alan Greenspan warned about a few years ago is long gone. In its place is "irrational panic" as investors sell everything they have at nearly any price just to escape the stock market carnage, and the psychological pain that goes with it. As a result, the market may continue to drop even though it has already lost 50% of its value since the slide began.

Thanks to the mass exodus from stocks, many top-quality issues have become screaming bargains with prices we have not seen in nearly two decades. Because values are now so high, I think long-term investors should start to buy the bluest of the blue chip stocks that are almost certain to recover once the super bear market ends – as it will surely do some day. I'm confident that investors who buy the world's best stocks at today's low prices will end up with outstanding profits in a few years.

Use Stop-Loss Orders Religiously

However, there is no need to expose yourself to a possible further decline in the stock market. To stay out of harm's way, I strongly suggest that you use stop-loss orders on every stock you own.
"Stops", as they are often called, tell your broker (actually his computer) that you want to sell a stock if it falls to a level you chose in advance. If the stop-loss order is never activated, it won't cost you a dime. If it is eventually needed, the sale will usually cost no more than your broker charges for your other trades.

For example, you might want to buy a promising stock for $20 that was selling for $100 a year ago. To protect yourself against another big drop, when you make your purchase you may wish to tell your broker to enter a stop-loss order for $15 (or any other price you wish). If anything should happen that drives the stock down to $15, it will automatically be sold.

And Keep Them Current

It is also important to keep your stop-loss orders up to date. If one of your stocks goes up 10%, you should then move your stop-loss order up 10%. Once again, it is easy to do and it won't cost a thing unless the stock turns around and drops to your stop-loss price.

An Added Bonus

Stop-loss orders have another big advantage investors don't realize until they start using them. Stops eliminate the need to make sell decisions when stocks are falling, a task most investors don't do very well. With stop-loss orders, you calmly pick your sell prices ahead of time. Later when the party ends, each sale will be automatic, and painless.

Details, Details!

There are three different types of stop-loss orders you should know about.

A stop market order will be executed at the best price available if a stock falls to the activation point you specify. However, if the market declines quickly, your order might not be executed until the stock is below the level you chose. Nevertheless, you will probably be out long before most investors even know there is a problem.

A stop limit order works the same way, except your stock can only be sold at the price you specify. In most cases, stop limit orders work just fine. However, if it is not possible to get your price your stock won’t be sold.

A trailing stop automatically moves up as a stock rises. You can specify a percentage of the price you wish to maintain, or you can chose a specific number of points. Either way, if the stock falls to your trailing stop, it will be sold automatically at the best available price.

Stop-loss orders have often been called "the portfolio manager's edge" because they keep losses under control. With losses limited, and profits allowed to run, stops can have a big impact on the performance of a stock portfolio.

Jim Powell