Rule 2 - Achieve break even stop as soon as possible.

Once you have made your first purchase you have 10% of the investment at risk (or 0.1% of the total portfolio assuming you have a $10000 portfolio and $100 invested as a seed). Your second purchase is probably your most important purchase as you start adding to this position to make it a larger low risk investment.

After your first purchase you are risking $10 (10% of $100 invested). As the stock moves up raise the stop to reduce the 10% to 0% at risk. DO NOT raise this stop too early. Most stocks will react a little on their climb up. It is better to wait for a reaction then as it moves up on volume (will talk more about price and volume in another blog) raise the stop. Maybe you can reduce it from a 10% stop to  3 or 5% reducing that $10 risk. When the stock has climbed above a recent consolidation on volume that is the time to make your second purchase of an an equal number of shares.

For example if you bought 10 shares at $10 (and you had your intial sell stop at $9) and the stock is rising on volume and lets say it is at $11, then it may be time to make your second purchase. The importance of the second purchase is to move your loss profile from a $10 loss to a $0 loss if stopped out. If you select an approximate mid point between the old purchase and new purchase price ($10 and $11) then place a sell stop at $10.50 for the whole position. Actually it would be slightly over $10.50 since your first purchase is a $100 investment and your second purchase is a $110 investment (I use Excel to store my positions and calculate my break even point).You should now be a happy investor since you have a position where if stopped out you lose no  money (excluding commissions).

You now have an investment of $210 and if stopped out at  the stop price will walk away with no loss. At this point you can add more stock to  the original poistion as it climbs. After the second purchase of your first stock when risk is reduced to zero you can consider buying a new stock and doing the same again on this new company. We will talk about this later but as stocks keep breaking out to the upside on high volume you keep buying another 10 shares in the above example. Over time the current stock price will move further and further away from the stops you recalculate each time. Every time you add to the position you recalculate your break even stop point and apply it. If this stock continues on up you will eventaully have large positions with very little chance of being stopped out.

You can imagine a time when you have made perhaps 20 purchases and have a lot of money invested. You do not wait for the stock to retreat to your sell stop level since you would be out at zero gain. You watch the rising stock and sell a portion (maybe 25% of your holding) if the trend changes and it starts falling. If it continues to fall then sell another 25% and another until your out of the position completely as it falls. Since you are selling stock for more than the price you paid then you have profit and when you put these numbers into Excel it has the effect of lowering the sell stop value needed to break even giving you an even bigger safety margin.

If the fall was temporary and the stock resumes its rise then start adding 10 shares at a time again. A word of caution dont get too greedy. If you start buying too many shares too soon as the stock climbs then the break even point gets much closer to the current stock price and you run the risk of being stopped out at break even on just a small correction. Keep adding just the 10 shares until you have a wide margin of safety between the current price and the break even stop price. If the gap becomes significant you can then consider buying 15 or 20 shares at a time and later on even more. A later blog will talk at length about price and volume also what stocks to buy and when to sell.

One more point to make this blog talks about how to handle a rising stock. Of course if your initial investment was a bad investment and the stock goes down you lose $10. This is an acceptable risk since your winning stocks will show much greater gains than that loss of $10. Dont go out and buy five different stocks with a $10 stop all at once because if the market turns down you have $50 at risk. Better to break even on an investment then start another.