New York (The Street) -- If you've owned Amazon ( AMZN) or Priceline.com ( PCLN) 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.
What If You Don't Already Own Amazon or Priceline.com?
First of all, be sure you want to own these companies. Amazon sells at dizzying PE ratios because the investment community sees it as a play on skyrocketing revenues, like the extra revenues Amazon should experience from its new service through the U.S. Postal Service that offers delivery of what was purchased on Sundays. Jeff Bezos and his team have an impressive track record of lucrative innovations and this one is no exception.
Priceline.com is selling for around 22 times forward earnings or a 1-year forward PE ratio of 22. That sounds very expensive compared to Microsoft ( MSFT) but if you compare how the stock of each has performed you clearly see investors prefer Priceline.
You can buy a mini-call option on both Amazon and Priceline and at the same time sell a mini-put option at the same strike price. Make sure the expiration dates on these mini option contracts go out far enough into the future so you have a better chance of seeing the call go up in price while the put you sold hopefully drops in value.
Some investors call this strategy a "synthetic long", and it's designed to let an investor or trader participate in the upside potential without committing a big chunk of your investment money. You can set up a trailing stop alert for Amazon and Priceline to help you stay focused that the underlying stock price is heading the right direction.
The discipline of a trailing stop is akin to the discipline of position sizing. Both are risk management strategies that are designed to prevent catastrophic losses while giving investors a fighting chance of experiencing some big winners.
Ask your brokerage firm about using mini option contracts for synthetic longs or,with mini put options, as a strategy that protects you if the stock or long-term call you own suddenly plummets in price.
Even if you just want to buy some shares of the high-priced stocks which includes Google ( GOOG) use a trailing stop monitoring and alert system that lets you know at the end of each trading day how close you are to the trailing stop loss percentage or dollar amount you've chosen for each holding.
Remember, a trailing stop is a huge help in making sure you lose just a little bit when you're wrong about the direction of an investment you're buying. Yet most of us face two big problems as traders and investors:
- When to cut our losses short...
- How far to let our winners soar before taking our profits.
That's why you need a way of pegging assets to their highest price during the period you've owned it. That's precisely what a trailing stop loss accomplishes. By using trailing stop loss alerts on the stocks you buy from the time you buy them, you can keep your emotions out of your way, predetermine what an unacceptable loss is for you, and look forward to letting your winners soar before capturing your profits.
Disclosure: At the time of the publication of this article the author was long GOOG and MSFT.
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