10: The Essential Rules for Beating the Market

Chapter 4. The Stop Loss Rule

"The best stress reliever is a smart stop loss order!"

Equation 4.1. 

So far you've learned the principles of Demand Fundamentals, the use of the price-to-earnings (PE) ratio to avoid buying expensive stocks, and the basis of technical analysis for picking the right time to open a new trade. In Rule 4, you will learn the right time to exit a position. This rule could be called the "Intelligent Stop Loss®" rule.

I believe this is the single most important concept of my approach to the market. There should be a huge star beside Rule 4! I have been "saved" from many whipsaw sessions in the market by using this strategy.

Whipsaw

Whipsaw is when a stock's market price makes a quick move up or down, followed by a sharp price change in the opposite direction. All too often, an investor will buy or short on a whipsaw event, only to be fooled by the sudden reversal and have to either sell or cover. Generally, an investor gets whipsawed when he or she does not follow a rigid set of rules that governs the timing of entry and exit points.

The objective of this rule is to hold onto a stock as long as it is making you money. "Making you money" is the important phrase here. It means you want to hold onto a stock as long as the stock's market price is trending or moving in the direction that provides an increasing level of unrealized gain.

Unrealized gain is the profit you ...