Smart investors plan for every contingency. With one simple technique, you can open the door to a huge opportunity. This chance only comes very rarely -- but when it does, it brings huge profit potential with it.
Last month, shareholders in Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) got a nasty wake-up call. The company's B shares began the trading day at $3,000 per share, down more than 20% from their previous close. Apart from the general panic going on at the time, there was no news specific to Berkshire that justified the move.
By the end of the day, the shares recovered nearly all of their losses. But a few lucky shareholders who had thought ahead felt like they'd won the lottery -- and scored on a bargain they may never see again.
The magic of limit orders
These well-prepared buyers didn't have fancy trading platforms or sophisticated software. They didn't have professionals watching the markets 24/7 for them. Many of them didn't even realize they'd picked up Berkshire shares until much later that day.
But they did place a limit order -- a way of trading shares in which you call all the shots. In contrast to a market order, where you agree to buy shares at whatever price someone will sell them to you, a limit order lets you decide how much you're willing to pay. If a seller wants to sell you shares at that price, then your limit order will execute. But if your price is too low, your order will remain open.
Many investors routinely use limit orders. Their primary benefit is that you always know how much you'll pay. That way, you protect yourself from unexpected short-term price spikes.
Yet especially when markets are volatile, limit orders can serve another purpose. They can help you take advantage of irrational movements in stocks you're interested in.
Good 'til canceled
When investors want to buy a stock and use a limit order just to control short-term fluctuations, they usually set their order to expire at the end of the day if it doesn't get triggered.
But if you're interested in picking up shares for your portfolio if they ever happen to trade below a certain level, you can use a good-'til-canceled limit order. These orders can remain dormant for months, but if a seller's ever willing to sell at that price, your order will still be there.
With the big ups and downs in the markets lately, you could've picked up some great bargains. Here are some examples:
|
Stock |
Lowest Price At Which Limit Order Would Have Filled |
Price One Week Later |
|---|---|---|
|
Southern Copper (NYSE:PCU) |
9.13 |
14.41 |
|
First Solar (NASDAQ:FSLR) |
95.32 |
152.09 |
|
Google (NASDAQ:GOOG) |
310.30 |
372.54 |
|
Best Buy (NYSE:BBY) |
20.00 |
26.88 |
|
PotashCorp (NYSE:POT) |
60.38 |
85.26 |
Source: Yahoo! Finance.
Limit buyer beware
The most challenging thing about limit orders is setting a price. On one hand, if you set your price too low, the odds that you'll ever see your trade happen are slim. Yet obviously, you don't want to set a high price, only to see shares fall further. That's an especially big danger when bad news knocks a stock for a loop. What may have seemed like a lowball price before an announcement can turn into a disaster for you afterward, bringing immediate losses.
But if you're investing for the long term, and you believe that your stock will eventually overcome any short-term difficulties, you can afford to risk of missing out on the actual bottom. By using value investing principles -- setting a price that reflects your estimate of intrinsic value, with an appropriate margin of safety built in -- you'll take advantage of momentary lapses of rationality in the markets. When you do, the profits can be virtually unlimited.
For more on making the most of current opportunities in the markets, read about:
- Stocks you must avoid now.
- Investments you can bet the house on.
- How not to poison your portfolio.
