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Ed. Note - This mailbag article first appeared on StockCharts.com back in 2000. It is just as valuable now as it was then, so we've added them to our new Mailbag blog. Enjoy!
Q: I appreciate Richard Rhodes' trading rules but I have a question. What rule do you use for taking profits on a winning trade? That is, you have entered a trade pursuant to your trading rules. You have been patient and the trade is profitable. Now the trade is going against you. When do you lock in your profits and get out? Also, when you enter a trade, do you set a stop loss? If so, at what level? Key support? A certain percentage of the entry price?
A: The rules mandate that on winning trades either the fundamentals must change, or a stop loss must be hit. As traders, we don't want to hit the exact high or low, for that is too difficult, and also keeps us timing the market in the short term. We don't like to pick tops or bottoms, for the major trends generally stay in place for a long time. However, stop losses tend to take you out on a non-emotional basis.
Stop losses are generally set as a percentage you are willing to risk on the trade every day or a technical level that must be broken - your choice. Reconcile the percentage drop you are willing to risk, and apply that to the support/resistance levels - compare and choose what is best for you. Also, these are not mental stops, rather they are entered on a daily basis. As soon as the trade is put on, a stop loss is entered.
- Richard Rhodes
Q: Don't REITs perform worse when interest rates rise?
A: Since REITs are often viewed as income producing vehicles, they are sometimes placed in the same class as utility stocks or bonds. When interest rates rise, one would expect that bond prices or utility stock prices would decline. Thus, one would also expect that high-dividend paying stocks like REITs would also decline when interest rates rise (or rise when interest rates fall). Well, one of my favorite sayings is that "Things are always more complicated than they seem at first glance." That is really true with REITs. As you can see from the chart below, it is more complicated than it seems at first glance.
Notice that in 1998, interest rates were going down (green arrow), so one would expect that REITs would rise in price, but instead REITs were declining in price. Here in 2000, rates are going down (blue arrow), and REITs have been rising in price. REIT share prices are sometimes affected more by supply and demand issues than by interest rates. Lower interest rates allow more builders to build more buildings, increasing supply and putting pressure on rents, so that could explain why lower interest rates result in lower REIT share prices. Likewise, higher interest rates slow down the building of new facilities, which eases pressure on rents, which results in higher REIT share prices. Nursing home REITs and medical care REITs have also been highly influenced by legislation on Medicare reimbursement, which greatly overshadows any interest rate influence on REIT prices. Recent changes in legislation have increased Medicare reimbursement rates, which is helping some of these REITs. Perceived instability or discontinuation of dividends can also cause REIT prices to decline sharply. REIT dividends are much less secure than coupon payments on bonds. Also, bonds generally have a set maturity date, whereas REITs usually have no maturity date. I wish I could make things simpler, but analyzing REITs is complicated.
- Rex Takasugi
