WASHINGTON, June 13, 2016 – We mentioned in our June 7 column that we’d soon explain the highly useful “GTC trailing stop” strategy that most seasoned traders and investors employ to save portfolios or individual stock holdings from sudden, sharp market declines. Although it was delayed, this special column may actually turn out to be uncommonly timely, given today’s and this past weekend’s scary and potentially market moving headlines.
So what’s a GTC trailing stop? Here’s the deal.
Even the Maven isn’t always sitting in front of his computer from 9:30 a.m. to 4 p.m., the market’s normal Monday through Friday trading hours. In case something nasty happens while he or you are away from the keyboard, we might want to put some defensive maneuvers into place that will be triggered automatically to save profitable positions before a selling wave swamps them with red ink.
Hence, that good-‘til-canceled (GTC) trailing stop. A simple “stop,” for our purposes here, is an order we enter to sell a stock we already own at a pre-set price that’s either X dollars or Y percent below where the stock is currently trading.
Say, for example, you own 100 shares of XYZ Corp. You bought them at $10 per share and they’re now at $15, a tidy paper profit of 50 percent. But you’re going on vacation for a week to a place where you know network connectivity is poor and you want to protect at least most of your profit in case something goes wrong while you’re away. So, either online (if you manage your own accounts) or via your friendly, full-service broker, you enter a good-‘til-canceled sell order on XYZ Corp. at, say, $14 per share.
As opposed to a one-day market or limit order, “good-‘til-canceled” orders stay on the books indefinitely. If XYZ never touches $14 dollars per share, the order never executes. But if it does, those clever brokerage house machines will take you right out of your position on the very next trade. In practice, of course, that could generally be a little above or a little below $14, depending on the next trade. But under most circumstances, you’ll be safely out of that stock pretty close to that price.
If you’re prepared to be a bit more creative, however, you might put in a GTC trailing stop order. To borrow my favorite Cheech & Chong comment, a GTC stop and a GTC trailing stop are the same only different. The plain old GTC stop order is permanently set at—in our example—$14. The trailing version of that stop allows that initial $14 mark to float upward by an amount you designate when putting in the order. Typically, you can either choose to have your GTC trailing stop order modified in either dollars and/or cents increments or percentage increments. (The Maven usually chooses dollars and/or cents.)
Depending on how each brokerage house typically handles such orders, what this means in or example is that if, while you’re on that vacation, XYZ goes to $16 per share from $15, and if your trailing stop was initially set at $14 but with instructions to trail the price of XYZ by $1 if it keeps going up, your stop will immediately move up to $15 when XYZ hits $16.
If you continue your lucky streak and XYZ goes to $20, the trailing stop will reset at $19. Ad infinitum until, one day, XYZ goes down over a point, triggering your latest trailing stop. Or until you cancel that GTC order, presumably once you’ve returned from vacation. Hence the C-part in “good-‘til-Canceled.
GTC trailing stops, properly applied (and considering the volatility of the stock involved), can save you and your portfolio from getting seriously hosed when you’re away from your desk during an extended period. They can also save you from ruining your and your family’s vacation as you halt or delay each morning’s fun to fire up your computer and hawkeye your positions.
Dangers to this strategy? In normal times, relatively minimal. But with volatile stocks, your stop could get hit and take you out of your shares on a violent, perhaps HFT-instigated gap down in price, even though later in the day that stock might end up considerably higher, setting your blood pressure on a hard boil. Well, no one said markets were perfect.
But in general, when the market starts getting really weird, like it is now, or when a potential Black Swan event like the potential Brexit looms menacingly on the horizon, the GTC trailing stop is your best defense if you want to embark on a reasonably care-free summer holiday.