One Secret of Successful Investors

If you wish to invest in individual stocks successfully, then you must have, and use, an exit strategy. And what's more, it must be one that forces you to methodically cut your losses and let your winners run on.

If you follow this rule, you will have the best chance of outperforming the markets. The exit strategy we favor is quite simple. It involves setting trailing stops for each of your individual stock positions. Then merely ride stocks as high as you can, but if you see them heading for a crash, use your exit strategy to protect your portfolio from serious damage. Here's how it works:

Let's say you decide to set a trailing stop of 20% off their highs for all of your stock positions. This means for example, if you buy a stock at $50 per share, and it starts to fall from that price, you would sell - if and when - that stock dropped down to $40 per share. No exceptions!

Conversely, if instead of falling, that same stock were to rise to $100 per share, and thus set a new high, you would then reset your trailing stop upward in order to reflect the new upward price movement. However, your 20% trailing stop would now be set at $80 per share, and if the stock were to decline in price from the $100 new high, you would then sell this stock - no matter what - if it fell in price down to the new $80 trailing stop.

Finally, there are two important rules to follow whenever you use trailing stops:

1. Use end-of-day prices, and sell out the very next day after the stock hits your trailing stop.

2. Don't place stop orders, because stocks very often close higher the very same day that your trailing stop was reached. Again, simply sell the day after you hit your trailing stop.

Note: One tool you can use to keep track of your trailing stops is Yahoo Finance's Alert Service. You'll receive an e-mail whenever your stock hits a price that you specify.

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