Setting limits.

Limit your losses by selling your stock when it reaches its target

Selling a stock or a stock fund isn't always easy You may be so attached to a winner that you'll keep holding on long after the winnings have stopped. Conversely, you might be unwilling to sell a loser and admit to a mistake.

You can take such emotions out of your investment decisions through the use of "limit orders." Such orders, accepted by most brokers, will automatically sell securities when certain prices are reached. You might, for example, set target prices for some or all of the stocks you own and place limit orders at those levels. If the stocks go up to those prices, the shares will be sold and the proceeds can be reinvested elsewhere, locking in your profits.

Say, for example, you own 100 shares of XYZ company, which is trading at $40 per share. You believe the stock will reach a peak of nearly $50 per share and then decline. Wanting to sell near the high, you enter the following sell limit order: "Sell 100 shares of XYZ at $45." Here the sell limit price is entered above the stock's current market price. If and when the stock's price rises to or above the limit price, the order will be executed and the stock sold at $45 or higher. If the stock never rises to the limit price, the order will not be executed.

Another way to use limit orders on the sell side is to enter "stop-loss" orders with your broker, A stop-loss order is used primarily to limit losses on profitable stock positions. As with a limit order, you enter a stop order at a target price or stop price. A stop-loss order becomes a market order to buy or sell the stock when it reaches the target price.

For example, if you buy XYZ company stock for $50, you might place a stop-loss order at $40, limiting your downside on the stock to $10 per share, which would be 20%. By raising your stop-loss orders as a stock moves up, you can assure yourself of a gain.

Suppose, for example, your $50 stock goes up to $70. You might raise your stop-loss from $40 to $60, to secure a gain from your original $50 purchase price. If the stock keeps moving up, you can keep increasing your stop-loss order. With a stop-loss order, you know that if the stock trades at or rises above the stop order price, a market order will be executed.

"Such strategies may be effective in some situations," says Dywane Hall, a principal in the Alexandria, Virginia, office of LPL Financial Services. "However, you have to use limit orders with care. A stock might fall from $20 to $15, triggering a stop-loss order, and immediately shoot back up to $25 or even $30. Unfortunately, you would have been sold out at $15 and missed the subsequent gain."

The answer may be to give yourself plenty of room when you set limit orders, especially for volatile stocks, such as those in the tech sector, that trade actively. Set a floor below which you absolutely want out of the stock but don't set the limits so tight that a dip can keep you from cashing in when the stock quickly rises.

Glossary of terms

Capital gain: The profit that results when the proceeds from the sale of a security are higher than the security cost basis.

Capital loss: The loss that results when the proceeds from the sale of a security are lower than the security's cost basis.

Cost basis: The price, for tax proposes, paid for a security, including commissions, markups, and other cost adjustments.

Day order: An order to buy or sell securities without a time notation. If it is not executed or canceled, it expires at the end of the trading session during which it was placed.

Limit order: An order to buy or sell stock immediately at the best available market price. No price is specified by the customer placing this order.

Market order: An order to buy or sell stock immediately at the best available market price. No price is specified by the customer placing this order.

Open order: An order that remains valid until it is executed or canceled.

Stop order: An order that becomes a market order to buy (buy stop) or to sell (sell stop) when a stock trades at a specified price, known as the stop price. Also called a stop-loss order.

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