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CHAPTER XI.

* CUTTING LOSSES SHORT.

We have spoken in previous articles of methods of trading. Experience proves that every operator should adopt one of two methods: Either cut losses short, or take an investment position. We propose to point out to-day some of the advantages of cutting losses short.

The buyer of any stock has some reason for his action. He has heard that the stock is going up; he believes that it is selling below its value, he sees that a bull market is under way and believes that this stock will go up as much as any other. These and similar reasons lead to buying.

It is obvious that in all but one of these cases the buyer does not profess to know anything definitely about the stock he buys. He acts on the suggestions or advice of others. Points are good when they are good, and under some conditions can very wisely be followed. There is nothing better in trading than to know that a great operator or a great syndicate intends for good reasons to move the price of a stock from a lower to a higher figure.

But almost everybody learns by sad experience that the “best laid plans of mice and men gang aft agley." Great operators change their minds about the expediency of market movements and most of them have learned that it is one thing to will and another to do in stock speculation.

*Dow's Theory.

Hence the trader who takes a point, even from good sources, has only partial assurance of profitable results.

His true protection in such a case lies in a stop order. If the price advances, well and good, but if it declines his stop order cuts his loss short, while those who do not stop the loss, but who listen to assurances that the market is all right, often see larger losses in the end.

The general rule is to stop losses within a range of two or three points from the purchase price. All purchases on points, tendencies and rumors should be regarded as guesses and protected by stop orders. Traders, looking over their accounts, seldom lament the losses of $200, which they find scattered through their books as the result of stops, but they deeply lament the $1,500 or the $2,500 losses which reflect over-confidence in a position which proved unsound.

The difficulty with stop orders is that they are frequently exercised when the event shows that the loss need not have been taken. There is no help for this, but the placing of a stop order can be wisely varied by the circumstances of a given case. Suppose, for instance, that the 5-year movement showed a bull market to be in progress; that there has come in this advance a 5-point reaction in a stock like Union Pacific and that a purchase had been made 5 points from the previous highest.

If the price declined 2 points more in such a case, it would probably be wise to exercise the stop order as the fall would suggest a down swing of larger proportions than had been anticipated. It might be such a move as occurred in December, 1899, when stop orders proved exceedingly

profitable in bull accounts. If the price subsequently recovered the 2 points, and the stock was repurchased at about the original price, it would probably be wise to put the stop order the next time about 3 points away, under a belief that the stock would not go quite so low as it went before and that the stop order would therefore not be executed.

If this reasoning proved sound, and the price advanced, the stop order could wisely be kept 3 points below the market price until the stock had advanced several points and showed signs of what is called "toppiness." Then it might be well to advance the stop order to 2 points and await developments. The stop order is of primary importance when a purchase is first made and when its wisdom is in doubt. It is also of primary importance in pyramiding; that is, where stock is being bought on an advancing market every point up, because in such a case the stop order is relied upon to prevent the turning of a profit into a loss. It is of importance when a stock has had its normal swing for the purpose of saving most of the profit if a reaction comes, while leaving a chance open for further advance. It is of least importance when a stock has been well bought and is slowly advancing. It should be set further away from the market at such a time than any other so as to avoid being caught on the small setbacks which occur in an advancing period.

By means of a stop order, an operator can trade freely in active stocks of uncertain value, which he would not venture to touch as an investment. By it, he can trade in much larger amounts than he could otherwise undertake

to protect. The stop order is the friend of the active speculator, who wants to make a quick dash for a large profit and who is willing to make small losses in the hope of getting a good run once in four or five attempts. It is the friend of the small operator, the out-of-town operator and the timid operator. It should be applied, however, only in active stocks where there is a large market. Stop orders should not be given in inactive stocks, as the seller may be slaughtered in their execution.

A stop order to sell 100 shares of Union Pacific at 75 means that the stock must be sold at the best price obtainable as soon as there has been a transaction at 75. If the best price were 74 or 73, it would still be the duty of the broker to sell. Hence the importance of not giving such orders in stocks where wide differences in quotations may be expected.

CHAPTER XII.

*THE DANGER IN OVERTRADING.

A frequent inquiry is: "Can I trade in stocks on a capital of $100, buying on a scale up and stopping my loss so as to protect my original capital ?”

There are a great many people in the United States who think about trading in stocks on a capital of $100 or $200. Many of them believe that if a thousand dollars is a proper 10 per cent. margin for trading in 100 shares, $100 must be a fair margin for trading in 10 shares. We regard this reasoning as sound, but dissent from the conclusion that $1,000 justifies trading in 100 share lots.

The reason is that nobody can hope to buy at the bottom or to sell at the top; or to be right all the time or to avoid losses. Making money in stocks for most people resolves itself into a series of transactions in which we may say there are six profits and four losses, resulting in a net gain. The experience of good traders shows that the operating expenses in trading, that is to say, the ratio of losses to profits, run from 50 to 65 per cent. of the total profits.

A man who may have made $10,000 gross in trading in a specified time will be very likely to have lost from $5,000 to $6,000 gross in the same time, leaving a net profit of from $4,000 to $5,000. Profits and losses run in streaks. There will be times of all profit and no loss, and times of

*Dow's Theory.

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