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Apprenticed Investor: Protect Your Backside

Friday, October 28, 2005 | 03:41 PM

The latest "Apprenticed Investor" column is up: Protect Your Backside

This week, we look at how investors can avoid get killedin "fiasco stocks."

Here's the excerpt:

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."

There's alot more where that came from.

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Source:
Apprenticed Investor: Protect Your Backside
RealMoney.com, 10/28/2005 10:34 AM EDT
http://www.thestreet.com/comment/barryritholtz/10250118.html