Parachute Investing

 

Ever jumped out of an airplane? It's OK ifyou have on a parachute. Pretty dumb if you don't.

Every buy any stocks, mutual funds or ExchangeTraded Funds? It's OK if you know how much youare willing to risk. Pretty dumb if you don't.

Parachute investing is buying an equity with a parachute so you won't risk all your moneyor, better yet, give back the profit you have madeas the stock or fund went up and then goes down. If you bought that hummer at $12 per share andduring the past couple of years seen it go up to$52 you don't want to give back that niceprofit, do you? With a parachute you can savemost of it. How?

When you invest in any stock of fund youmust know how much you will risk before you buy itand how much of the profit you are willing togive back when it turns down. Take that beautyat $12. Instead of going up it went down. Areyou willing to agonize as it drops to $5? If youhad a parachute you would have jumped out of theplane before it crashed. If you had an exitstrategy for your stock you would have sold itbefore you lost a big chunk of your cash.

The secret of a safe investment is an exitstrategy. When you bought Mr. Twelve Dollars youshook hands and told him I'd like to be yourfriend, but if you change your name to TenDollars I am leaving. Maybe that that is notvery nice, but nice doesn't cut it in theinvestment world.

Mr. Twelve Dollars said I am going up andI want you for my friend. Please follow me and ifI falter you can leave and we will part friends. Now that makes sense. You trail along and afterit goes to $52 it does falter. Do you know whereyou are going to leave or are you going to rideit go back down to $12? In other words do youhave your parachute on?

That parachute is your continuing exit strategythat is in place every day. In the investmentcommunity it is called an open trailing stoploss order. Any broker can put this in place foryou. You might be lucky enough to have a brokerwho knows where to place stops, butunfortunately there are not many of them.

The brokerage industry does not teach itsemployees (brokers) how to protect customers'money. If that is the case you might want to usethe old standard 10% rule. Have the broker placean open stop every Friday at 10% of the closingprice of that day as it closes higher. Neverlower the stop loss. Brokers hate this as itmakes them work, but that is what they are therefor and that is how they earn their commissions.

With your parachute you can always protectyour original cash purchase from a big loss and asyour stock advances you can lock in profit asthe stock advances.

Every investment should have a parachute.

Copyright 2005

 



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