Page 333 - How to Make Money in Stocks Trilogy

M = Market Direction: How You Can Determine It 209

Selling short can be profitable, but be forewarned: it’s a very difficult and
highly specialized skill that should be attempted only during bear markets.
Few people make money at it. Short selling is discussed in more detail in
Chapter 12.

Using Stop-Loss Orders

If you use stop-loss orders or mentally record a selling price and act upon it,
a market that is starting to top out will mechanically force you, robotlike, out
of many of your stocks. A stop-loss order instructs the specialist in the stock
on the exchange floor that once the stock has dropped to your specified
price, the order becomes a market order, and the stock will be sold out on
the next transaction.
It’s usually better not to enter stop-loss orders. In doing so, you and other
similarly minded investors are showing your hand to market makers, and at
times they might drop the stock to shake out stop-loss orders. Instead,
watch your stocks closely and know ahead of time the exact price at which
you will immediately sell to cut a loss. However, some people travel a lot and
aren’t able to watch their stocks closely, and others have a hard time making
sell decisions and getting out when they are losing. In such cases, stop-loss
orders help compensate for distance and indecisiveness.
If you use a stop-loss order, remember to cancel it if you change your mind
and sell a stock before the order is executed. Otherwise, you could later acci-
dentally sell a stock that you no longer own. Such errors can be costly.

How You Can Learn to Identify Stock Market Tops

To detect a market top, keep a close eye on the daily S&P 500, NYSE Com-
posite, Dow 30, and Nasdaq Composite as they work their way higher. On
one of the days in the uptrend, volume for the market as a whole will increase
from the day before, but the index itself will show stalling action (a signifi-
cantly smaller price increase for the day compared with the prior day’s much
larger price increase). I call this “heavy volume without further price
progress up.” The average doesn’t have to close down for the day, but in most
instances it will, making the distribution (selling) much easier to see, as pro-
fessional investors liquidate stock. The spread from the average’s daily high
to its daily low may in some cases be a little wider than on previous days.
Normal liquidation near the market peak will usually occur on three to six
specific days over a period of four or five weeks. In other words, the market
comes under distribution while it’s advancing! This is one reason so few peo-
ple know how to recognize distribution. After four or five days of definite