Barry Ritholtz

Try Jim Cramer's Action Alerts PLUS
CLICK HERE NOW

Apprenticed Investor: Protect Your Backside

10/28/05 - 10:34 AM EDT

Barry Ritholtz

A Fool & His Money

Using a modest stop-loss strategy, you could have bought Enron at its peak and limited your losses dramatically. Here's an example of how even an outrageous calamity like Enron need not be a total nightmare to a well-prepared investor:

Let's say someone was foolish enough to rely upon the sell-side analysts' "strong buys" on Enron in 2000. Our hypothetical investor -- let's call him Kenny Boy -- got suckered into Enron at the worst possible time, buying 1000 shares at its peak price of $90.

When he bought the stock, Kenny employed the very simplest loss limitation -- a straight 15% stop loss. He placed a "good till canceled" 15% stop loss order at $76.50. (Next week we'll go over a variety of stop-loss techniques.)

Towards the end of the year, Enron had broken $80 and was sliding further south. By mid-December 2000, the stock was flirting with Kenny Boy's stop point. Soon after, Kenny Boy was "stopped out" of Enron at $76.50.

Still, Kenny Boy's a sucker. He read a few positive articles on the company with titles like Enron's Power Play that got him excited again. As the broader market bottomed in April 2001, Enron appeared to stabilize. Just as Enron rallied to $60, poor Kenny Boy went back for more punishment. He bought another 1000 shares, with the same 15% stop in place.

A month later, the stop loss took Kenny Boy out again. This time, he was sold out of at $51, for a $9,000 loss.

Meanwhile, as the stock price slid, institutions may have been forced to dump shares in order to stay true to their investment style. For example, a large-cap growth fund, by its own charter, may not be allowed to hold mid-cap stocks. As a widely owned issue like Enron cratered, it created a self-fulfilling "death spiral."

As this was happening, our hypothetical investor remained a true glutton for punishment. During the post-9/11 swoon, Kenny Boy "caught the falling knife," once again picking up 1000 shares of Enron at $30. At least Kenny Boy was disciplined; he again relied on the 15% stop loss.

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.


Barry Ritholtz


10/27/05
Still Seeing Upside in Japan

The same strategy that got me bullish on Japan in 2003 remains intact.


09/14/05
Game Over in the Blog Search Space

Google's new search for blogs is far superior to those of its competitors.


09/09/05
Ignore the Pundits -- Katrina Will Hurt

The economy and stocks will feel the effects eventually, and the bull will die with a whimper.


05/19/08
Cramer on Top Searched Stocks: Yahoo!

Yahoo! is among the most searched stocks on TheStreet.com. Here's what Cramer had to say about the stock recently.


05/17/08
Jim Cramer's Best Blogs

Catch up on his thinking on the hottest topics of the past week.


04/26/08
Coming Week: Make or Break

Investors will have to deal with a Fed meeting and another flood of earnings and economic data.


05/19/08
Top Rocket Stocks: Ensco

Ensco International and Echelon have the potential to move higher in coming days.


04/28/08
Monday's Analysts' Upgrades, Downgrades

See who made what calls.


05/19/08
Telecom Giants See a Savior in Video

The addition of video is helping telecom companies compete against cable and satellite companies.


05/19/08
Contract Expiration Tempers Oil's Rise

The June West Texas Intermediate contract reflects selling pressure ahead of Tuesday's expiration. But stocks in the sector are generally trading higher.


05/19/08
Analysts' Upgrades, Downgrades: Amazon

See who made what calls.


Your Recent Quotes: Quote Up0 | Quote Down0
Dow S&P 500 NASDAQ
Oil*
Gold
10 Yr
0.00%
%
%
%
Data delayed 20 min
Sign up for our FREE newsletters now.

Keep on top of the market and the critical information you need to make more profitable investing decisions.

  • Cramer's Daily Booyah!
  • Before the Bell

Privacy Policy

See All Free Newsletters

Premium Stock Ideas