How should I use stop losses?

Wednesday, Sep 04 2019 by
3

Hello everyone

I hope that you are not looking for advice on how to use stop losses! Obviously that is because I am looking for advice!

I have been investing successfully in shares for 30+ years and had never considered stop losses until now. But recently I read an article in  Investors Chronicle and then I bought "The art of execution" both of which strongly advocate the use of stop losses as a way of minimising losses. I use Stockopedia's great new Stop loss alerts, which are of the trailing variety.

I would really like to hear from subscribers that use stop losses. My questions are:

1) Are your stop losses fully automatic or do you have to  instruct a trade? Why?

2) Do you treat the alerts as discretionary or mandatory? Why?

3) If discretionary, then do you sell immediately or do you wait to see if the limit is still broken at the end of the day? Why?

4) Do you make your decision to sell purely based on on the stop loss, or do you only sell if other factors such as a profit warning or a bad news release  arrive? Why?

5) How successful or unsuccessful do you consider your use of stop losses to be?

I would really appreciate your advice on this because it looks like it could be a good step forward, but only if it is done in the right way.

Thanks.

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. The author may own shares in any companies discussed, all opinions are his/her own & are general/impersonal. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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37 Posts on this Thread show/hide all

herbie47 5th Sep 18 of 37

Anyone who had stop losses when the Brexit vote happened may remember what a nightmare they were. With my broker I could not cancel as they were pending, you had no control over what sell price you would get and did not know if your shares would be sold or not and when and for how much.

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pka 5th Sep 19 of 37
1

Hi WarrantStar,

This video doesn't answer your questions, but you might find it amusing:

https://www.youtube.com/watch?v=LiE1VgWdcQM&list=RDLiE1VgWdcQM&start_radio=1&t=2

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gpacker 5th Sep 20 of 37
3

In reply to post #510646

Everything is relative and has to be put into perspective, but you are right to express concern on the face of my approach summary.

For me using a 2:1 leverage, and lets say an initial 10% stop loss on a 10k account:

2:1 ratio = leveraging to a 20k account.
4 x 5 k positions
4 x maximum £500 losses
= A 20% loss on cash/account should all 4 stocks hit the stop loss.

However, my strike rate is 58% and my risk reward ratio 4 to 1 (over a large sample), my average loss is actually 6% when taking into account raising/trailing stops.
The volatility of my stock selections is low and the stops are placed in strong support, coupled with strong fundamentals and a momentum catalyst etc.

Without such stats I agree the approach could be seen as risky, but with the right approach the reward outweighs the risk which is always the trade off. In this system its a play on probabilities and playing enough that the edge materializes.

I generally hold 8 or more positions so I'm better diversified than the example above, should all positions hit the maximum stop loss and I lose 20% of account, this kicks me out of the market until the market improves. Therefore a large unrecoverable drawdown is unlikely.

We have seen a volatile 2019 and you will note the volatility of my fund is low in comparison.

I also hedge the portfolio with 20% gold which counteracts volatility (usually...)



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WarrantStar 6th Sep 21 of 37
2

Thank you to everybody for the tremendous quality of your responses! What I am going to do next is go through them all in some detail. I will then  form some conclusions for what is likely to work best for my style of trading and post it on here.

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unwise2 6th Sep 22 of 37

I would add one other comment, stop losses are most important on your initial purchase to protect capital. Once you have a decent gain you can decide if you want to use a trailing stop or not. If you think you might be onto a long term winner leaving your stop at breakeven can give the stock more room to fluctuate.

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pka 6th Sep 23 of 37

I have been experimenting recently with using a discretionary stop loss that is activated when the %50dMA / 200dMA of a stock is less than 100. I haven't been using this stop loss criterion long enough to draw any conclusions about its effectiveness or otherwise on the performance of my portfolio.

There's more information about the %50dMA / 200dMA here:

https://www.stockopedia.com/ratios/50d-moving-average-vs-200-day-moving-average-5357/

https://www.stockopedia.com/content/trading-the-golden-cross-does-it-really-work-69694/

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WarrantStar 6th Sep 24 of 37
1

This is my attempt to summarise everyone's comments when applied to my trading style which is fundamentally driven, buy and hold quality growth companies with market capitalisation above £50m, mostly high flyers (but not the most expensive ones). The general comments on here are that stop losses are: inappropriate, unsuccessful, lock in losses, do not prevent big losses on profit warnings, prevent you from holding successful companies for long enough to make significant gains. 

Thanks again for everyone's comments.  I have to say that I am surprised by them. I had started this post in the belief that it was a good idea for me to start to use stop losses, and that I just had to do it in the right way. Now I coming round to the conclusion that I should not use them at all! But I am also left wondering why it is that the book "The art of execution" was so convincing that stop losses were so successful for fund managers that were operating on a buy and hold basis. Has anyone else read it?

Apologies in advance to anyone who feels that I have misrepresented or omitted their views in my summary above. 

All further comments welcome!

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herbie47 6th Sep 25 of 37

In reply to post #510861

Probably based on the US market which I believe behaves differently from the UK one. Stop losses work for some type of traders. I doubt Warren Buffett uses them. For momentum/short term traders I can see why they use them.

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unwise2 6th Sep 26 of 37

In reply to post #510861

But I am also left wondering why it is that the book "The art of execution" was so convincing that stop losses were so successful for fund managers that were operating on a buy and hold basis. Has anyone else read it?

Yes I have. Stop losses are fine with buy and hold if used correctly. The reality is most investors that experiment with stop losses don't pay much attention to the share price chart. If you buy stocks that are extended from previous bases the possibility of being stopped out is very high.

Even when timing purchases correctly the long term win ratio for successful investors/traders is only 50% (in bad markets it can be as low as 25-30%)*. Most people cannot cope with being wrong at least 50% of the time.

It doesn't matter if you make money on only half your investments if your losses are much smaller than your gains.

* Read When the best fail, Pg 4 The art of execution.

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WarrantStar 6th Sep 27 of 37

In reply to post #510866

Herbie

Yes indeed the book was based on the US market.

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wilkonz 6th Sep 28 of 37

In reply to post #510866

Correct! Warren Buffett doesn't use stop losses.

https://www.cnbc.com/2019/02/2...

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WarrantStar 6th Sep 29 of 37

In reply to post #510876

Is it really just a case of:

If you buy on fundamentals, then you should sell on fundamentals

If you buy on technical analysis, then you should sell on technical analysis

If you buy on one and sell on the other, then you will suffer? 

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gpacker 6th Sep 30 of 37
1

In reply to post #510981

Sorry completely disagree, you can invest singularly in terms of Technicals or Fundamentals OR you can combine both. I combine both on a weekly chart which complement each other perfectly and I make a good living from it.

One learning from years of investing is to keep an open mind as to what does and does not work.

AND find your niche.

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HumourMe 6th Sep 31 of 37

How about shortlist on fundamentals, buy on evidence of institutional accumulation (going up (or sideways, if patient)), sell on evidence of institutional distribution (going down) or fully valued?

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doublelutz 6th Sep 32 of 37

In reply to post #510996

I pay little or no attention to what institutions are doing. Their holdings can go up and down like a yo-yo on a day to day basis. I certainly pay attention to director purchases that being one of the things I look for in selecting shares.

I missed the discussion yesterday so will not go into detail but I think you should always have a mental note of when you would get out of a share. However, it is pointless having say a 10% stop loss. It needs to be based on the chart wherever possible.

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WarrantStar 6th Sep 33 of 37

Or how about this proposition:

The proportion of fundamental analysis & technical analysis that one uses on ones selling decisions, should be the same  proportion as is used on one's buying decisions.

In my case the buying decisions are mostly fundamental, with a little technical analysis.

So when I consider selling, then it should also be based mostly on fundamentals, with a little technical analysis.  So as far as the use of stop losses is concerned, if my discretionary stop loss is breached, then I should also be looking for a deterioration in the fundamentals before pressing the sell button.

Does that make sense?

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doublelutz 6th Sep 34 of 37

In reply to post #511011

Well there are as many ways of doing it as there as investors. I NEVER use charts as the main reason for buying a share but I do use them to support my decision which often comes down to the level of director's buys, whether there are covered dividends and a lack of short sales. However, the chart then takes over as the main determinate for closing the position.

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Neil66 6th Sep 35 of 37
3

1) Are your stop losses fully automatic or do you have to instruct a trade? Why?

Automatic ... Sometimes! Manual ... sometimes! No stops at all .... sometimes!

It all depends on: the market character; my level of conviction for the holding; and how busy I am in other areas of my life.

2) Do you treat the alerts as discretionary or mandatory? Why?

There have been market phases where I have placed automatic stops, and other market phases where I have applied more discretion. If I believe that the market is rising but significantly over-extended - then I have automatic stops in place and will allow them to take me out of the market (e.g. late January '18). If I believe that the market is fundamentally ok (earnings still growing) but going through a rough patch - typically trading sideways with VIX > 16 and VXN > 20 intermittently - then I may remove stops althogether to avoid "bleeding to death" through whipsaws - e.g. end Feb '18 through end August '18. If the market has been trading sideways with elevated VIX and VXN for some time and I am exposed to risk with no gains occuring - then I am supposed to "get out of Dodge". Trouble is, if you apply too much discretion how do you avoid staying in the market during a significant correction without rigorously apply a market timing model? e.g. October '18 through to Christmas Eve '18? Essentially, its not just about Stops, but also about reading the market character.

At the present time I have no stops in play at all - despite Trump, despite Trade-wars, despite Brexit, despite inverted yeild-curves. I dont expect any of these factors to be resolved any time soon - and in any case earnings are still growing.

I dont know of any stop-loss strategy that is robust to "tweeting" market sensitive information: Trump.

3) If discretionary, then do you sell immediately or do you wait to see if the limit is still broken at the end of the day? Why?

When discretionary, then it would be at the end of the day at the earliest - I work for a living!

4) Do you make your decision to sell purely based on on the stop loss, or do you only sell if other factors such as a profit warning or a bad news release arrive? Why?

If the stock in question is one where I have no strong long term conviction - then I will be more likely to just close out the trade. If the investment is high conviction then I would be more likely to "Hold on for Dear Life" - even during an overall market down-turn.

5) How successful or unsuccessful do you consider your use of stop losses to be?

Mixed. Really, this is a statistical game and all we can do is attempt to apply methods to manage risk and tilt the statistics in our direction ... just a little. Reading the market character is, I believe, an area where having a tool to help gives you a genuine advantage in minimising draw-downs.

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Mike888 7th Sep 36 of 37
2

I generally have a single reason for buying a stock, but many reasons to sell a stock, and all if those selling reasons and thresholds are known when I hit buy.

it is therefore almost impossible to have an automated stop loss, my only exception being leveraged positions which  have the benefit of being guaranteed.

I'm a firm believer of sell strategies, I am also a firm believer that the market is more knowlegable than me. The market makes the price and it doesn't matter how clever or dumb I am, I can't influence it, so my overriding rule, on buys and sells, longs and shorts, is listen to the market. You beat the market by doing so.

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wilkonz 8th Sep 37 of 37

In reply to post #511101

'The market makes the price and it doesn't matter how clever or dumb I am, I can't influence it...'

Very true. As Keynes once said: 'Markets can remain irrational longer than you can remain solvent.'

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