By SIMON CONSTABLE
Sometimes when you've made substantial gains on a stock or exchange-traded fund, you face a tough choice: Do you sell to lock in the profit? Or hold on for more gains but risk losing what's been made?
Mr. Elfenbein notes that once you have a gain on paper, it's psychologically very hard to watch it disappear. The ability to protect those gains makes the trailing stop order very appealing.One way to have your cake and eat it too is to use a trailing stop order: an order to sell your position if the price falls by a predetermined percentage or dollar amount. Most orders are set 20% below the current price, says Eddy Elfenbein, editor of the Crossing Wall Street newsletter. Some people also periodically cancel the orders and reset them at higher prices if there is a rally. Stop orders cost a little more than simple market orders.
But these orders aren't without peril. "There is a risk you get 'stopped out' of a good position," Mr. Elfenbein says. How so? Flash crashes—or temporary drops caused by electronic trading glitches or errors—may cause a position to be sold when it would have been better to hold on.
Another risk: When the stop price is reached, the order is filled at the market price. During periods of market disruption, that can mean you get a price much lower than where the "stop" was placed.
Trailing stops also are available for short sellers, who sell borrowed stock hoping to buy it back later at a lower price. Their stops take the form of buy orders set above the current market price.
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