A few days ago I received the following email from Heath:
...I bought Nutri system (NTRI) which I consider a company with meaning, moat and solid big 5 numbers. It was ranked as the top growth stock and had many positive things going for it. It was below the MOS so I waited until the 3 technical indicators said buy. When that happened, I bought a little over $1,000 worth of shares. I watched the stock slowly gain day after day. I checked my charts every day. Everything was going great. My investment grew to a 5% gain in a couple of weeks.
Then all the sudden, it dropped 12% in one day. Unbelievable. I went from a 5% gain to a 7% loss before I knew what had happened. All three indicators said sale (of course) but they did not say sale the night before. Now I’m in a mess. If I sale, I’ve violated rule #1. If I do not sale, I’ve not done what the charts said do. I NEVER GOT A CHANCE to sell this stock without loosing money. My understanding was that if I buy and sell by the three charts, I would not loose money. I thought the big investors could not get out that fast.
Where did I go wrong? What do I do now? Do I violate rule #1 and loose money or do I keep the stock and ignore the charts?
This is a good lesson for all of us: ANY stock can turn down on us, but one that is already doing that is much more likely to continue doing that.
There is a saying: The Trend is your Friend. Look at the chart on NTRI and you'll see that NTRI peaked about 2 months earlier at $75 and then BANG!, gapped down to $57. That's a clue gang, that something is shaky in dietville.
I'd be very careful with this one after seeing that previous gap.
Still, NTRI is compelling enough to draw us in. So how do we protect
ourselves in the event of a sudden melt-down?
We use a trailing stop loss. This is a clever little thing you do on the on-line brokerage site you are using to place the buy or sell order. Put your trailing stop at about 8% so it trails along automatically as the stock goes up. You can call the broker you use and they can tell you how to properly do it on their site.
In this case, since you decided to go forward on NTRI in spite of the down trend (which is okay... down trends are a kind of advanced view of the world), then you need to use a trailing stop to get you out if things change and you didn't see it coming.
In this case I'm guessing you went in at about $54, saw the stock climb to $57 and then boom!, it went to $50, then $48, and now it's back at $50. A trailing stop would have taken you out at about $52. It's a loss, but only about 3%.
Another point to make here is that if you use technical tools like I do, you are going to have a lot of sideways trades and even a bunch of negative trades like this one. It's part of the price of insurance that tech tools give us that we won't be stuck in a meltdown.
Another point is that Heath thinks he hasn't lost money because he hasn't sold yet. Not true, Heath. You lost the money. You made some of it back but not all of it. Pretending that you haven't taken a loss just because you haven't sold is a very bad habit if you are going to trade. Save that mind-set for the stocks you are going to buy and hold no matter what. With stocks that you trade, you have to deal with reality every day.
In this case, the stock is headed back up, so I'd sit in it and see if it climbs back. But if it starts to turn down again, Heath, then you need to decide if NTRI is a buy and hold forever thing for you or if you are trading it. If you are trading it, then get out on the signals.
And don't forget to use stop losses to help you if you aren't paying attention on the critical day. If you were watching your money, you would have seen red red red in the morning that it opened at $52 and you would have sold right there.
Now go play.