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How to Buy Amazon, Priceline and Limit Downside Risk

New York (The Street) -- If you've owned Amazon (AMZN - Get Report) or (PCLN - Get Report) for at least a year, you're probably feeling very good. With Priceline hitting a new 52-week high on Wednesday at $1,126.76 a share, your original investment capital has nearly doubled, and if you've owned Amazon, you're ahead by over 62%.

Now's a smart time to protect your gains, wouldn't you say? How do you accomplish this without spending a fortune? If you believe in using options as downside "insurance" you can buy a "mini" put contract for every 10 shares that you own and choose a "strike price" just below the current stock price level.

Another strategy to protect your gains is to set a trailing stop-loss order that will convert to a market order if shares of Amazon or Priceline fall a specific percentage or dollar amount that you've established in your trailing stop loss order. For example, if you set a 25% trailing stop loss percentage, when the shares fall 25% from the highest price level it attains from the moment you've placed the order, you're brokerage will automatically sell your shares.

The problem with this approach is that when you place any kind of stop-loss or a sell-limit order with your brokerage firm, you're in essence telling the exchange that these stocks trade on that you're "willing" to sell if the shares fall to the level you've chosen in your order. With high-frequency trading programs and algorithms that search for groups of sell orders (and essentially that's what a trailing stop loss order is, a sell order), you might find yourself the victim of a mini-flash-crash.

A mini-flash-crash is precipitated by a trading program or a group of computer trading programs that can temporarily drive the price down to where a large amount of sell orders currently exist. When the price momentarily drops these sell orders are converted to market orders and your shares are sold. Then the market-makers assigned to Amazon or Priceline fill any or all buy-limit orders that happen to be at the same price level.

The outcome is you've sold low and somebody or some fund has had the pleasure of buying low. That's why I think it is better for the smaller, individual investor to use a trailing stop loss alert system that the market-makers and the exchanges can't see. There are optimal trailing stop loss percentages for each stock that helps you to stay invested during volatile market conditions and follows the stock higher as it reaches for the stars.

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AMZN $372.10 0.00%
PCLN $1,164.15 0.00%
AAPL $124.43 0.00%
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