You invest to make money. When you buy a stock, your objective is to sell it at some point down the road for a profit. Planning your exit strategy (the price at which you would be comfortable selling your shares) is a critical component of a more disciplined approach to investing.

BMO InvestorLine is pleased to offer clients two types of orders, Hard Stops and Trailing Stops (see below). These orders allow you to plan and set up your exit strategy at any point, even as early as when you are placing your buy orders. These tools will help you manage your investment portfolio, lock in your gains and minimize your downside risk.

The idea behind a Trailing Stop Order is to have the order follow, or “trail”, a stock’s price as it rises. Your Trailing Stop Order’s trigger sell price*, or Stop Price, is re-calculated upwards each time a new Closing High** is reached. If the stock’s price begins to fall and reaches your calculated Stop Price, your order will be triggered as a Market Order and your stock will be sold for the best available price.

By following a stock’s price as it climbs and triggering a sell order if the price falls below your specified threshold, a Trailing Stop allows for the potential of greater gains, versus relying on a strategy that locks in gains once a firm or "hard" price is reached (Hard Stop).

Benefits of Using Trailing Stop Orders
How many of us have held stocks in our portfolios that performed like stock XYZ in the chart below? If only we had a tool that could manage our downside risk so that we get out earlier with potentially greater gains (or minimized losses). All too often we delay selling when our stocks start to show a downturn, in the hopes that the decline is temporary and the price will recover.

You buy stock XYZ in March 2002 at $20/share. Once your purchase is confirmed, you set up a Trailing Stop to be triggered at 20% off the highest price in this stock’s current growth cycle. Stock XYZ reaches its highest price of $40/share in May 2002. Note that stock XYZ did fall from time to time during its growth phase between March 2002 and May 2002. However, these dips in price were never 20% from the highest Closing Price (which would have triggered your order).

In July 2002 the share price begins to fall. From the highest Closing Price of $40/share in May, your order is triggered to sell when the price falls by 20% to your calculated Stop Price of $32.00/share, $8.00 below the high. In this example, you would not have realized the highest possible price of $40/share, but you would have locked in a gain of $12.00/share.

Setting up a Trailing Stop Order does not guarantee that you will actually sell the stock at a price higher than you bought it. For example, if you bought at $20/share and set up a Trailing Stop with a Percentage of 20%, your initial Stop Price would be $16/share. If the stock does not rise above $20/share, but instead falls to $16/share your order will be triggered as a sell order (at market) and you could lose $4/share or more (see Limit Variance and Stop Limit for details). However, once your order is filled, you are protected from further losses if the stock’s price continues to decline. By setting a Trailing Stop Order, you establish in advance the maximum loss that you are prepared to take on any one investment.

Plan your exit strategy up front when you buy. Using Trailing Stop Orders as a tool to manage your exit strategy can help you ride your strong performers and minimizes your downside risk on your under performers.

Let’s walk through an example of how this might work. Our discussion of a Trailing Stop Order will define each field on the Order Entry screen and describe its use. In this example you decide that if stock XYZ ever falls 20% below the highest price in its current growth cycle you want to sell. You are now ready to enter your Trailing Stop Order as follows:

Previous Close:
The initial calculations for a Trailing Stop Order are based on the previous day’s closing price. To display the previous closing price for your stock, click on the Get Price button beside the Previous Close field.

Percentage and Stop Price:
The Percentage you select is initially applied to the Previous Close to calculate the Stop Price that will trigger your order. The order's Stop Price will be re-calculated upwards, based on your selected Percentage, each time a new High is reached at the close of a trading day (Closing High).

For the purposes of this example, let's assume yesterday's close was $20/share and that you selected 20% as your Percentage. Your initial Stop Price is calculated as a 20% reduction from the previous day's close, or $16.

Now let's assume that over the next few days stock XYZ's price gradually increases and closes at $21.00/share. Your re-calculated Stop Price, based on your selected Percentage of 20%, will be reset at $16.80. In this way, your Trailing Stop Order follows, or "trails", the stock price as it rises and re-calculates your Stop Price each time there is a new Closing High to lock in potentially greater gains.

To minimize the number of small fluctuations in your order, your Stop Price will be re-calculated based on the following minimum increases in the previous Closing High:

Please note: Trailing Stop Orders are only accepted on stocks valued at $5.00 or higher.

Limit Variance and Stop Limit:
When your Trailing Stop Order reaches its Stop Price, your order is triggered* to become a Market Order and your stock will be sold for the best available price. In volatile markets or with volatile stocks the price you receive may be considerably lower than you expected. To reduce your downside risk, you have the option of selecting a Limit Variance in those markets which will permit it.

The Limit Variance is a restriction on your order which is used to calculate a Stop Limit price. By placing a Stop Limit on your order, you are saying that you will not accept a price less than the Stop Limit for your shares. The Stop Limit is calculated as the difference between your current Stop Price and the Limit Variance you specify (Stop Price - Limit Variance = Stop Limit). Each time your Stop Price is re-calculated upwards, your Stop Limit will also be re-calculated upwards, based on the Limit Variance you specify.

Using our original example of stock XYZ with a previous closing price of $20/share, you select 20% as your Percentage. Your calculated initial Stop Price is $16/share. If you select a Limit Variance of $1.00, your order now has a restriction on it. Your order will be triggered to sell at $16.00, but will be held if the market price falls below $15.00 before your order is filled (the difference between the Stop Price of $16.00 and your Limit Variance of $1.00).

If you leave the Limit Variance blank, your order will be triggered as a Market Order without restrictions. If you indicate 0 in the Limit Variance field, you will not accept anything less than your Stop Price for your shares (when your Trailing Stop is triggered, it becomes a Limit Order at that price).

Markets which permit the use of a Limit Variance to calculate a Stop Limit include: the Toronto Stock Exchange, the New York Stock Exchange and the TSX Venture Exchange. This feature is not available for Nasdaq listed stocks.

Good Till:
A Trailing Stop Order is good until filled or until you cancel the order. This field is set automatically on your Trailing Stop Order.

For related information, please refer to:
Hard Stop Orders
Sell on Stop Orders
Stop Orders - Frequently Asked Questions
The Oxford Club “Investment Safety Switch” report (pdf)

Note: You will need Adobe Acrobat Reader to view and print the Oxford Club “Investment Safety Switch” report.

The "Investment Safety Switch" report is made available through special permission by The Oxford Club. For more information on The Oxford Club or its "Investment Safety Switch" report, please visit www.oxfordclub.com.

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*Triggered: Trailing Stop Orders are triggered as a Market Order when the Last Sale Price of a board lot reaches your Stop Price, except on Nasdaq, where a matching Bid will trigger your Trailing Stop Order. If you wish to place a Stop Limit restriction on your order by setting a Limit Variance, your order will not be filled for a price that is less than your Stop Limit. Stop Limits are not allowed on Nasdaq. Trailing Stop Orders are executed on a best efforts basis. We cannot guarantee that your Trailing Stop Order will be executed at your Stop Price once your order is triggered to become a Market Order.

**Closing High: The last highest closing price for the stock since the Trailing Stop Order was placed (not necessarily the previous close). The Trailing Stop percentage is initially applied to the previous day's closing (Previous Close). Subsequently, this percentage is applied to any new Closing High. For more details, please refer to Stop Orders - Frequently Asked Questions.