Sterling Weekly for October 17th, 2005

Well it is Tuesday afternoon, and prior to today's comments from one the Fed governors regarding interest rates the overall market looked as if a rally was starting. Whether today's comments and what is looking like a down day will cause the rally to fail or whether it follows through remains to be seen. But it does provide a good starting point for this week's topic; the need to use trailing stops to protect a position as you never know when it will turn. For those of you who are unfamiliar with the term; a "trailing stop" is a stop order that is automatically adjusted as a position increases in profitability and typically executes at a set distance from the maximum gain. Its purpose is to allow a position to increase in value and yet close out the position as it turns.

A good example of a trailing stop in action would be the trading of Trans Ocean 'RIG' last Friday's recommendation in the Sterling Prime Stock Newsletter. I recommended a short sale on the shares of 'RIG'. The shares of 'RIG' open opened at $53.76/share, and moved lower for the 1st hour of trading reaching a morning low of $52.62/share. This is a decline of over $1.00/share. Typically I will look to protect my profits in a position once it has gone profitable by a quarter. It depends upon the stock, but I'll typically set my stops to trail by $0.15/share. Under this scenario, if I would have been able to go short at the opening price, I would have then set my stop on 'RIG' once its price dropped below $53.51/share. With a trailing stop set at $0.15/share, the stop price would have continued to move lower as the price of the shares dropped to $52.62/share. After reaching this price the shares of 'RIG' began to rally. At $52.77/share my stop would have triggered and the shares of 'RIG' would have been automatically been bought back in order to cover the short. This would have given me a profit of $0.99/share minus commissions.

I believe that with every trade you must know your potential exit points. You should also realize that you never know when a trend will reverse itself. My number 1 Rule of Trading is to never let a profit turn into a loss. The proper use of a trailing stop is a good way to help ensure that the 1st Rule of Trading isn't violated.