How to Avoid a Painful Investment Mistake

If you buy a house for $400,000, would you immediately advertise that you are willing to sell for $300,000?

Of course, you wouldn't.

But I think that many subscribers recently did the equivalent of this in the stock market last week. It was an honest mistake, but they lost millions of dollars because of it. Please read today's message and make sure you don't commit the same mistake they did.

Here's what happened...

At around 12:15 p.m. last Wednesday, trading slowed down on shares of Quest Capital (QCC), one of my recommended stocks. Trading slowed down enough for the greedy market maker in the stock to hatch his plan. He'd probably been waiting for weeks to pull it off. And last Wednesday, he did.

I don't know this for certain. But my explanation is likely, and it's a good time to explain why I always advocate that you never enter stop orders in the stock market.

What I believe happened in this case is a number of people put stop orders in the market at 25% below the market price. I am a strong believer in using trailing stops. However, I do not recommend you actually enter those orders in the market.

It's for the same reason that you'd never buy a house for $400,000 and then immediately put it on the market for $300,000. You never want to show the world what your worst-case exit plan is.

It is my belief that people did exactly this.

Last Wednesday, Quest opened at $2.80 and closed at $2.70. This small decline shouldn't sound any alarms for anyone... Quest has been in a trading range of $2.60 to $2.80 for most of 2007. But for a brief moment on Wednesday, at around 12:20, the stock traded all the way down to $1.71, before jumping right back up to its trading range for the year.

To try and avoid this situation, I base trailing stops only on end-of-day prices... If the stock closes on a day below "X" price, then sell the next day. This way, you never have your order in the market. You never show your hand.

In short, it appears that some inexperienced investors got their pockets legally picked by a market maker. It is disgraceful on the part of the market maker. The market maker is required to make an orderly market. I think he waited for just the right moment – a Wednesday lunchtime lull – when he had no buy orders, and just for one moment, he moved the market down and picked off all those stop orders.

It must have been irresistible for him. He likely took a few million dollars right out of the pockets of a bunch of regular investors. Again, it's disgraceful. But the victims literally handed it to him. These investors – through their stop orders – legally offered to sell their assets for 25% below the current market price. And this guy legally took them up on their offer to sell. 

In my newsletter True Wealth, I always say "Never put your stop orders in the market!" I always use end-of-day prices to determine when our stop is, so you can't get stopped out midday. "If the stock closes below our stop, sell the next day."

Unfortunately, in order to do this right, you must follow your own trailing stops. Fortunately, two relatively inexpensive services can help.

One is called TradeStops.com. One of our subscribers, who has a PhD in mathematics, developed it. The site is incredibly easy to use. Just put in the symbol, the date you bought, and price you bought in at. The site then tracks your stops for you. It even sends you an e-mail when you reach a stop. It does a lot more. Check it out at www.tradestops.com.

Another service is XLQ. This service allows you to control stock market data through Excel spreadsheets. I use it and like it. Among the many other things it does, it can keep track of your stops. It is free to try and not very expensive to buy. Check it out at www.qmatix.com.

Please, don't let this happen to you. Many people lost real money, because they showed their hand. It was a very harsh lesson for them. Please, learn from their mistakes. Do not enter stop orders in the market. Instead track your own stops. I've given you a few easy ways to do it.

Good investing,