A: Stops are among the best risk management tools in the investor’s toolbox. This simple technique can help you protect your capital and your profits while still limiting your downside and keeping your upside (which is theoretically infinite) intact.
A trailing stop is an order to your broker to sell a stock automatically if its price falls to a predetermined percentage below its highest value since the stock was purchased. Since the bioscience sector is more volatile than most, Ernie will usually recommend using at least a 35% trailing stop on positions.
Here’s how that works.
If you buy XYZ stock for $10.00 and set a trailing stop of 35%, then the initial stop will be $6.50. Should the security drop below $6.50 without increasing above $10.00, your stop will be triggered and the position will be closed automatically. However, if the security moves to, say, $18.00, your trailing stop will follow that rise up to $10.40 (35% below the high price). From there, it can keep going up, or if the security drops to $10.40, the position is closed.
Another type of protective stop is a calendar stop. Rather than following the price, a calendar stop simply determines how long we will hold the position before closing it – say, six months or one year. Ernie may sometimes recommend employing these on more volatile positions.