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Wednesday, March 18, 2009

Stop Losses

Excerpt from David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2009


First, a word about terminology. The term, “stop loss” is also referred to as a “stop order.” Essentially, it is an order to your broker to buy or sell a security once the price of the security has climbed above or dropped below a specified stop price. When the specified stop price is reached, the stop order is converted to a market order and you get the next price of the security.

For purposes of this primer, I am primarily focused on the aspect of implementing a stop loss to be executed once a security you own goes DOWN. This is designed to protect you from further losses.

The stop loss concept is very simple, deceivingly so. Say you purchased a stock at $100, but didn’t want to risk anymore than 10% of the money you invested. You put a stop loss at $90, and if during intra-day trading the stock traded at $90, your stop loss order would be triggered and you would be sold out of the stock at $90 (assuming a liquid stock) and you would be out of your position. If the stock then went to $1 a share, you would be congratulating yourself on how smart you were to limit your losses to $10 a share. If the stock touched $90, triggered your stop loss, but then shot up to $500 a share, you might be kicking yourself for years to come. The latter would produce strong feelings of seller’s remorse. But it wouldn’t destroy your portfolio. It would simply mean you would have lost out on an opportunity.

What is the difference between a "stop loss" and "stop limit" order? A "stop loss" order WILL sell your shares immediately once your stop-loss price is executed. In my current QQQQ trade, once shares hit $24.97, the next trade below that will automatically sell my shares. A "stop limit" order will ONLY sell my shares if QQQQ trades at $24.97 and there is a buyer at the other end. The difference between the two could come into play if, for example, the market opened way way lower (i.e. after a terrorist attack). Suppose the QQQQs gapped from $26 and opened up at $20 when they resumed opened for trading. Under that scenario, the stop-limit would not have been executed, and I would still own the shares, whereas the stop-loss would give me the first trading price below the stop-loss price (presumably $20 in this hypothetical).

The stop loss can be one of the most important tools in anyone’s investment portfolio. But its importance is not so obvious. And the reason for that is a premise that I ask you to consider by answering the following questions:

How easy is it for you to buy stock you don’t own or purchase more shares of stock you do own? (assuming you have the funds)

Now ask yourself this question. How easy is it for you to sell a stock that you own?

Here is the really tough one. How easy is it for you to sell a stock that has already declined from the price you paid for it?

If you are like me, and most humans, the truth is that it is very hard to sell a stock at a loss. As a position starts declining, our brain’s wiring goes into an irrational mode. Behavioral finance has studied this phenomenon and offers several explanations to describe the psychological reaction that occurs. One theory is that individuals follow the Kubler-Ross model of the Five Stages of Grief when a stock that they were certain had the potential to go up, declines markedly. First, you go into denial that the bad news impacting the stock is true. Then you are angry and blame third parties (such as short-sellers for example). Then the bargaining process begins (well if I wait a little longer, things will turn around or I could double up on my shares). Then depression — being paralyzed by the movement, and finally acceptance. The problem is the acceptance part of it all comes way too late in the game. By then, the stock has already gone through its declines.

The breakeven fallacy is adopted by many investors who are in a losing position. The brain rationalizes the losses under the fallacy that the security will reach a break-even point at which they put their money in and at that point they will sell. This might work for a diversified holding like the total stock market provided you have an extremely long investment horizon, but it doesn’t work so well for individual issues. (As a side note, some traders assign support and resistance levels to stocks that they believe represent a break-even point for many investors. But that is a topic for another day).

The stop-loss order, in my opinion, should be decided in advance of your purchase. Why? Because if you do it then, you are not emotionally vested in the position. Your ego won’t be bruised because you made a mistake and purchased a stock that immediately went down. By setting the stop loss in advance, you are simply evaluating how much you are willing to risk losing before you even put a penny of your money into a stock. If you wait until you establish a position, and then there is a sudden move in the stock in either direction, the stop-loss level you choose will be colored by the emotion of what just happened to the stock and you might act irrationally.

Trailing Stop Losses

When stocks are rising, I like the practice of using trailing or laddered stops. A trailing or laddered stop is simply a stop order that is raised periodically to compensate for changes in the price of the security. Trailing stops can be used to protect against losses, and to lock in profits and let them run. A trailing stop that is incrementally changed to follow the current trading price allows profits to continue, but presumably is far enough away from the current price level to compensate for intra-day volatility as price moves into a larger trend. That is exactly what I am doing now relative to the QQQQ shares. A word of caution: make sure you cancel your previous stop order every time you raise it.

Some online brokers offer trailing percentage stop orders. These types of stop orders work with a ratchet effect, trailing price movements by a set percentage but only in the direction of the trend. If the price reverse direction, the stop remains at the previous level and will be activated if price reverses by more than the trailing percentage. Here is a link to an article showing visually how this works:

Another Example

Some people think stop-loss orders are only for the penny stocks. Not true by any stretch. Let’s use one of the bellwethers by way of example. Suppose you purchased General Electric back in the 1999-2000 time frame. General Electric was considered the bluest of the blue-chip companies at the time and was one of the most widely held stocks, not only by institutions but also by individuals as well. Jack Welch was at the helm and over his 24-year term, the company went from a market cap of $14 billion to $410 billion. From 1990-2000, the stock had risen from $10 to $60, and shares had split three times with hardly a correction along the way. A series of trailing stop losses with enough room for relatively contained pullbacks would have allowed you to capture the bulk of the gains before the stop loss ever was triggered.

When the bear market of 2000-2002 came about, if you had been exercising trailing stop losses, you might have been able to lock in a large part of your gains. (It depends of course on how deep your trailing stops were).

Now flash forward. For about 5 years (2003-2008), General Electric was trading in the neighborhood of the $30-$40 range. There was probably a lot of cumulating of the stock during this time frame. In the last 52-weeks, GE traded as high as $38.52. The $30 was certainly a support level that stood for a long time, even as of September of last year. The stock then slowly, but orderly, declined from about $30 to about $12 last November when the market reached its lowest point of 2008. The stock then rallied a bit going into the new year, but once again started its decline to eventually hit its 52-week intra-day low of $5.87 on March 4th, and closing low of $6.69 the same day. It has since rallied to $9.62 where it closed Friday.

There were many times over the course of the last decade that a stop loss would have prevented much more serious losses in GE. The same holds true for many stocks (particularly in the financials and housing stocks) over this bear market.

Incidentally, I used GE as an example here in part because the company was in the news this week when Standard & Poor’s credit rating agency downgraded the company from AAA to AA-Plus, the first time ever. Barron’s has a feature article out this weekend saying that bonds of GE’s financial arm, GE Capital, are looking attractive despite still holding some risky assets. GE Capital’s bonds are yielding a full percentage more than those of the parent company. That kind of individual corporate bond ain’t my cup of tea, but if it interests you, here is a link the Barron’s article entitled, “GE: Bringing Good Bonds to Life”:

A final word about stop loss orders and trailing stops and the like. There is no panacea to investing. Charter subscribers of mine have seen me get stopped out of a position that subsequently rallied. Other times, I couldn’t have been happier that a stop loss was triggered. JP Morgan Chase is a good example of that last year. I think on balance, the use of stop losses has been net very positive for me and I encourage all of my subscribers to learn as much as they can about them. To that end, let me know if you have any follow up questions on this topic.

To learn how to subscribe to my newsletter, simply click on the link at the top of this web page. - David Korn

DISCLAIMER: The information contained in this newsletter and or published on my web site, is not intended to constitute financial advice and is not a recommendation or solicitation to buy, sell or hold any security. This newsletter is strictly informational and educational and is not to be construed as any kind of financial advice, investment advice or legal advice. Copyright David Korn, L.L.C. 2009.

David Korn writes "The Retirement Advisor" and "David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service" newsletters.

Monday, February 23, 2009

Bob Brinker, Moneytalk and Charlie Maxwell

Excerpt from David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2009
February 21-22, 2009 Newsletter

On Saturday, Bob had on one of his favorite guests, Charlie Maxwell, Senior Energy Analyst for Weedon & Co. Charlie was educated at Princeton and then Oxford. He has been working in the oil industry since the 1950s. In the 1960s he became an analyst on Wall Street and has been rated the #1 energy and oil analyst on many occasions. Bob heaped heavy praise on Charlie as the best of the best in terms of energy analysts and mandatory listening for Moneytalk trekkies. I summarized the important parts of the interview below.

Bob noted that we are hearing a lot about alternative energy, such as wind and solar power from the White House and asked Charlie to comment. During the course of the interview, Charlie touched on the major energy issues. I decided to break them down by topic for your ease of reference.

Wind Power

Maxwell: Charlie said the first problem is the wind doesn't always blow. Sometimes when you have heavy hot spots, there isn't wind for a long period of time and you have to replace that energy with coal or some other fuel. You would have to build that extra capacity because you never know when you would need it. Plus, it takes a lot of energy to make the infrastructure for wind energy, and there are other problems with it, such as birds that get killed in the propellers. Even when they do produce electricity, the wind farms are often in areas that they would need to transport the energy produced to where it is needed. Charlie said even if we put money toward it, the best we could get it up to over the next 15-20 years would be 3-4% of our power needs. However, it will never be a large proportion of energy source for the simple reason that the windy parts of the United States are quite far from where the power is needed. If the wind doesn’t blow, you need the coal generating capacity already built to replace it. The result is that while you might produce energy from wind, you have to spend money on substitution energy sources for when the wind doesn’t blow which is a huge added-on cost to wind power that many people don’t consider.

EC: On T. Boone's web site promoting his energy plan, he states that the Department of Energy reports that 22% of America's electricity can come from wind with North Dakota alone having the potential to provide power for more than 25 years. Read about it here:

Solar Power

Maxwell: Charlie said we produce much less solar power than wind power today. It only accounts for about 0.1% of all the energy we use in this country. Charlie said that even by spending a lot of money on it at best over the next 20 years, solar could only provide 1.5%-2.0% of our energy needs, so it is also not something we can rely on.

EC: I was checking my notes, and Charlie was on Moneytalk a couple of years ago and forecast that solar would only constitute 1% of our future needs. Today, he said it could go up to 2%. Why am I even bringing this up? Well, 2% is a 100% increase over 1%, even though the total piece of the pie is still small. Thought it was worth noting since I think it represents a significant change in forecast, although Charlie’s bottom line view about solar hasn’t changed.

Maxwell: Another problem is that solar energy isn’t a dense source of energy. The result is you spend a lot of time and energy making solar panels and thus the net power the solar cell generates is not that much compared to what it cost to put it there.

EC: Last week, I was writing about “green” investments that might benefit from the stimulus plan. There is an article out this week you solar fans might be interested in entitled, “Solar-power firm fired up about stimulus” which you can read at this url:


Maxwell: Charlie said there are some very encouraging developments for a source of energy that could really help us. Charlie said we have excellent long term prospects for developing clean energy from coal. We are learning how to sequester the bad stuff like CO2 and other pollutants and isolating them deep under the earth where it won’t harm the air. Charlie said we won’t have this for another decade as the technology is not fully developed yet, but it is something we can look forward to with relative confidence to using in the future.

EC: The notion of “clean” coal energy is not without controversy. As you might expect, some think clean coal is an oxymoron. Learn more about the concept at this url:

Natural Gas

Maxwell: Without coal being able to contribute much over the next decade in terms of clean fuel, we have to look to other sources. The good news is that we are finding out new ways of getting a lot of natural gas from under the ground. Over the last five years, there have been some incredible new horizontal drilling methods. Using new cracking techniques with sand, we are getting a lot more gas than we got in the past 20 years. Now the gas business is growing and of vital importance to us. Charlie said natural gas as a fuel for transportation is an area where the current administration could really make some strides. It has such potential, it could be as big as nuclear energy. Japan already produces cars that use natural gas, but we need to make a concerted effort to bring that to our country.

EC: Natural gas prices hit a 7-year low this week. Natural gas was trading at $3.01 per 1,000 cubic feet on Friday, less than a third since last July and the lowest since 2002. The Energy Information Administration is forecasting wholesale prices to average $5.01 per 1,000 cubic in 2009 and $5.93 in 2010.

Nuclear Power

Maxwell: Charlie lamented the fact that we don’t yet have the broad-based public support needed for nuclear power. Charlie opined that nuclear energy is safer than it ever has been. We have had 5 generations of new equipment developed since Chernobyl and Three Mile Island. The rest of the world is using nuclear power safely and efficiently.

Charlie pointed out that we have about 400 nuclear units under United States control that we don’t think about much — those are the naval ship and submarines that use nuclear power. We are one of the world’s nuclear powers because of our navy and we have a resource of many fine men and woman who are familiar with that power. But it takes about 8-10 years to design and build nuclear plants, so there has to be a movement now if we want to get those online in the next decade. Charlie said he does think there will be a ground swell of support for nuclear power in the next 4-5 years in our country.

Caller: A caller pointed out to Charlie that the New York Times ran an article about how Sweden was somewhat resistant to nuclear power a decade ago, but they have changed and are now embracing it. Charlie noted that the France, Japan and Canada have all done well with nuclear power. Charlie said he doesn’t think the main problem with nuclear safety is human error anymore, it is terrorism. That is an issue that we will have to address. It is not insurmountable. But we need stricter security since a determined group of people can do something awful.

EC: I found the New York Times article entitled, “Sweden Takes Another Look at Nuclear Power” at this url:

Battery and Hybrid Technology

Maxwell: A caller asked Charlie whether we have the resources in North America to mass produce fuel cell and battery technology. Charlie said it is a concern and China is tying up a good deal of minerals around the world. There are going to be shortages of various metals. The good news is that we do have a large amount of these resources, particularly in Alaska and Canada. There are some metals in Africa and Asia that we don’t have that we will have to trade for. But for the rest of them, we are in pretty good shape.

EC: By some estimates, Africa holds 30% of the world’s mineral resources, including much of the world’s platinum and chromium. Course, they got lots of the the good stuff like diamonds and gold as well (over 50%).


Maxwell: Oil prices have been crushed. Charlie noted there was so much public and government commotion when prices where going up, but nobody seems to be paying attention to it now. Charlie said he is concerned that the debate over fossil fuels has waned. The recession has created a supply/demand scenario where we can enjoy lower prices of oil — but it is only temporary. We are not solving the problem. As soon as China, India and the emerging markets begin to recover, we are going to see oil, coal rand gas rise again. It won’t be long at these low prices where the whole energy price system will turn back to rising demand. Charlie said we need to prepare for the time frame of vulnerability between 2012-2025 where we won’t have enough coal, or oil and will have to depend on natural gas. All of this we will come back to tough days with high oil prices so we need to keep our guard up.

EC: These comments jive with my own view for establishing a position in oil. The more I think about it, the more I believe that it makes sense to diversify an investment portfolio not only across different stocks, sectors, and countries, but also asset classes. Given the availability of ETFs to do that these days, it makes it easier than ever if you want to.

Energy Efficiency

Maxwell: By creating greater efficiency use of the energy we have, that in a sense is another source of energy. Charlie said he thinks the final revolution in energy over the next century will be conservation and efficiency. We will be able to maximize our resources in a more cost-effective and less wasteful manner.

EC: I always enjoy it when Charlie Maxwell is on the show. He is a real class act. Charles Maxwell's bio is at this link:

DISCLAIMER: This e-mail is neither sanctioned by, nor written under the auspices of ABC Radio Networks, Moneytalk or Bob Brinker. This e-mail is not a substitute for listening to Moneytalk, it is only my interpretation and commentary of some of what is discussed on Moneytalk, along with additional educational information that I include, editorial comments about the market and helpful financial links. I also provide my own stock market commentary to subscribers as part of my service and give them access to my web site, http:// If you want to know what was said verbatim on Moneytalk, listen to the show live or subscribe to "Moneytalk on Demand" which allows you to listen to the show in case you missed it live. The web site, has all the links to the ABC Radio Network stations that broadcast the show live. The information contained in this newsletter is not intended to constitute financial advice and is not a recommendation or solicitation to buy, sell or hold any security. This newsletter is strictly informational and educational and is not to be construed as any kind of financial advice, investment advice or legal advice. Copyright David Korn, L.L.C. 2009.

David Korn writes "The Retirement Advisor" and "David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service" newsletters. Just ask us for details on how to get a discount on subscriptions to both newsletters.

Saturday, February 14, 2009

Bob Brinker/Moneytalk/Stephaen Fitch/Pensions

Excerpt from David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob
Brinker Host), Financial Education, Helpful Links, Guest Editorials, and
Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2009

If you enjoy listening to Bob Brinker, I write a newsletter that provides commentary on the radio show Moneytalk. Here is an excerpt from my newsletter last weekend in which Bob Brinker had guest, Stephane Fitch, who recently wrote an article entitled “Gilt-Edged Pensions.” Here is a synposis of that interview. To find out how to subscribe to my newsletter,

Fitch’s article discusses the pension obligations of states and municipalities. The article begins by giving the real life example of Glenn Goss who retired from the Delray Beach, Florida police department at age 42 after working there for 20 years. He immediately began drawing a $65,000 annual pension that is guaranteed for life, is indexed to keep up with inflation and comes with full health benefits! That is the equivalent of a $2 million package based on the present value of his vested retirement.

After retiring at age 42, Goss did what most of us would do. He went out and got another job, this time as police chief in Highland Beach making $90,000 a year and building another pension. This idea of retiring a multi-millionaire in your early 40s is usually reserved for corporate executives. The surprising thing is a large number of public employees are able to retire with very significant benefits.

Fitch said Goss is a good guy and simply following the rules of the system. Fitch said cops put themselves on the line and so he has no problem with compensating them at a high level. The problem is that huge retirement pensions for public employees have put many states on the hook for billions upon billions. Fitch noted that Illinois is $60 billion behind; New Jersey $50 billion behind; Florida is behind $25 billion. The only way to close the gap is tax hikes and the reduction of services. They will get paid for because they are guaranteed by State constitutions. Nobody is bailing out private citizen’s 401(k) plans, but as taxpayers we will be required to fund those pension plans.

Fitch said you can try and blame the union bosses, but they are simply doing their job to get the best deal for their members. The real blame is the politicians who make the deals. The politicians who are coming into office now have to deal with the issues. Fitch noted that state and local government workers are getting paid an average of $25.30 an hour which is 33% higher than the private sector’s $19 according to our government’s own labor statistics data. When you add in pension and other benefits, the gap grows to 42%.

Fitch said that if you have a private sector company, and the company can’t afford its obligations, bankruptcy is often a solution. Fitch noted that the reality is that States aren’t going to declare bankruptcy, and even if they did, chances are a bankruptcy judge would still make the State pay these pension obligations since they are constitutionally backed.

Four in five public-sector workers have lifetime pensions, versus only one in five in the private sector. When small municipalities get behind, there is really not much they can do about it. With the market declining so much, it has become an enormous problems, even for bigger government entities. Fitch used Chicago as an example. They have a Fireman’s pension fund that is 19% funded, or 81% under-funded. It shows the irresponsibility of a generation of politicians. At best, they felt that the market would bail them out and continue to generate extraordinary returns.

Caller: A union negotiator called up and said that Fitch didn’t point out that many of these public employees who receive pensions don’t get social security. He thought it was unfair that public servants are unfairly targeted. Fitch asked how many States will come up with the money to pay for the pension benefit shortfall. Fitch said the unions aren’t to blame, the politicians and lawmakers are in bad faith as they gave out something they couldn’t afford.

Caller: A caller pointed out that his city once published the salaries of all city workers and people were astonished to see how many six-figured incomes there were, and that much of it came from overtime wages. Fitch noted that the average New York City employee makes $107,000 a year. That is breaking the City’s budget. In California, prison guards can earn $300,000 year with overtime pay.

Fitch said that in Las Vegas, Nevada, fireman can collect an inflation-protected $40,000 a year for life on top of their pension for disability and they can collect that even if they are healthy enough to work in another occupation. If you get heart disease, you would qualify even if you could work another job.

EC: The article Fitch wrote is an eye opener and worth a read. Check it out at this url:

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