Stop Loss Remove the Fear

10th Nov '17 by Ken Lowes

11 comments 3265 reads

Why is it that so many people including me don't like stop losses and yet the best people in the industry will tell you that you shouldn't trade without them. I came across this which I think might just solve the problem. https://www.youtube.com/watch?v=DW_EFskrCpc.

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About the Author

Ken Lowes

Premium Member

Retired but still an active investor

11 comments

slopsjon

10th Nov '17

Depends what you are trading. If you have an illiquid stock and put a 10% stop on it with your broker, there is a good chance you will be stopped out. If you are trading FX then you should definatly have hard stops and in the case of the swiss franc to euro a couple of years ago it should have been a guarenteed stop.

A hard stop on stocks may not save you from a 20% - 50% profit warning price drop. In many cases the stock will open down passed your stop before your broker has a chance to initate it. Most brokers don't act on stops for the first 3 to 5 minutes after open and then they have to work through their stop list and find a buyer all while the price maybe dropping.

I haven't watched the video but its from IG so a lot of it will refer to index, FX and that type of leverage trading. So it may not all apply to stock investing.

Rusty2

10th Nov '17

So one sided, gets to the problem page and there is nothing. I think it should be balanced with the pros and cons.

Stop losses are not guaranteed. Why is he advising people to invest 20% or 40% in one share? So put 40% in one company, shares are suspended and it goes bankrupt, Globo, Fairpoint (LON:FRP), Entu (UK) (LON:ENTU), could be some examples. Poor advise.

Actually I'm quite disappointed with IG.

Blissgull

11th Nov '17

The 2% rule discussed in that video seems to be taken from the books of Alexander Elder, which I think should be read by every aspiring derivatives trader.

There is a problem however, in that the rule is designed for trading, in particular derivatives trading on margin, rather than stockmarket investing. I would imagine that most Stockopedia subscribers are investors rather than traders.

Most futures traders specialise in just a few markets and have a small number of highly geared positions at any one time. Stockmarket investors on the other hand tend to have greater diversification, and there is a much higher correlation between their investments, i.e. whereas two futures contracts in say coffee and copper may be reasonably independent, a portfolio of twenty shares is going to be affected by general stockmarket conditions.

So consider a long term investor with a portfolio of 25 shares, equally weighted. Each position is 4% of the portfolio so using the 2% rule a stop loss would be placed at 50%. That is probably further away than most investors (who use stops) would like and it still exposes the investor to a substantial risk of up to 50% of portfolio value in the event of a major market downturn.

Elder actually recommended that the 2% rule be used together with a 6% rule, which was that if losses reached 6% in any given period (he recommended 1 month) then the trader should stop trading completely for the remainder of that period, close all positions and take a break to figure out what went wrong.

Ken Lowes

11th Nov '17

Hi
I think if you watch the video you will then find it helpful it is more than simply about placing a stop loss, it is more about risk management. Apart from that I agree with all that you say regarding stop losses other than the fixed percentage. Try this https://www.youtube.com/watch?v=_yeAtLrYfm8&feature=em-subs_digest-vrecs.

Ken Lowes

11th Nov '17

I understand your point and would never place a stop so tight or invest so much of the portfolio in one stock- but look at it a different way-- does it matter how much you have in a decent stock if you know that you are unlikely to lose more than 2% of your total portfolio, shall we say £1000? Which is better a fixed quantity or an unknown guess. Not using a stop guaranteed or otherwise will be very painful at some point. The statement "well I will keep it as a long term hold" can only work for a limited period and if you are dealing in small companies a recipe for disaster as Paul Scott mentions in the recent interview.

Ken Lowes

11th Nov '17

Hi BlissgulI
The formulae is Stop Loss designed to be never more than 2% of your portfolio. £100k portfolio stop so that you never lose more than £2000 on any trade, which means each trade will be of a different value, rather than an equal amount. It is an exercise in managing risk. Share Price £10, you decide where the stop should go based upon price action rather than a flat percentage, so let's say the stop should be placed at £9. 20 divide £2000 by 80p = 2500 shares and buy 2500 shares. As Minervini says you should know where to place the stop before you make the trade. In some respects what he is saying is if you are not comfortable with where you have to place the stop, don't make the trade. Obviously with penny stocks it is more difficult because of the volatility, so reduce the amount to £500 risk, place the stop further away and buy less of them.

Rusty2

11th Nov '17

But you don’t need a stop loss to sell shares, you can decide yourself when to sell, I often sell on negative news at prices well above a stop loss. Stop losses are not guaranteed, so you are not limited to 2%; I had a stop loss on Lakehouse (LON:LAKE) at 80p I believe shares fell from 90p to around 40p, my broker did manage to sell at 60p. After brexit vote shares fell in panic selling, many were sold after large falls only to bounce back, you could have lost half your shares. I agree you need to manage risk and for some people they are a good thing, but it does take decision making and control away. After being stopped out do you buy back the shares? Loss to me is about profit, if I get stopped out and then the shares go up 100%, I have lost about 110%, if I had 10% stop loss. End of the day it’s about how much your portfolio is worth, if stop losses help achieve higher worth then that’s fine but if they reduce it as in the case of being bounced out of decent stocks it’s not. Warren Buffett use stop losses? He will probably buy more if the price falls. Why do supporters of stop losses think people without them don’t sell their shares?

Ken Lowes

11th Nov '17

Hi Herbie
Always enjoy reading your responses. I agree with your suggestion regarding not setting a stop with the broker. but it takes an iron will to act when you should, perhaps if you had set a stop on Lakehouse at a support level or whatever you would have been out earlier and the words "managed to sell" would be redundant. The whole idea of stops are to manage risk, unless you are an investor for the long term when it would be a pointless exercise. The exercise we are discussing is not about a 2% stop loss, it is about risk management and my reply to Blissgull may help. In answer to your question would I buy back in, yes of course if the breakout reoccurred, if the share is really a good one and not just a dud that I thought was good, my small loss by being stopped out early will be simply a statistic. So far this year I have closed out over forty trades and my current position had I not sold would be a £2000 loss, yes some have gone on to make a 100% but many more have lost upwards of 20%. Minervini writes in his latest book about record keeping, and I can attest to the fact that keeping good records is just as important as finding good shares and not losing money is far more important than making money. Reading what Paul Scott says in his latest interview should be a lesson for us all. If he had to sell his house what chance for the rest of us. Manage the risk Herbie and you will be one of the 10% survivors. As for buying on the fall that is the road to madness, I find it difficult to buy more on the rise! At the end of the day Herbie, my friend, hope you don't mind me calling you a friend, but you do contribute so much to this site, at the end of the day it is about how much you have in the bank, Paul went from five million pounds to bankrupt in one bear market. I have seen it so many times.
Regards
Ken.

Ken Lowes

11th Nov '17

Hi Again
Hope you found the video useful but here is the one I meant to send you. https://www.youtube.com/watch?v=nZeavIuaXrA&t=56s

pone

11th Nov '17

I would say a lot depends on liquidity of the stock. For a poorly traded stock, your stop loss sets you up as fodder for the market makers. I have more than once set a stop loss, had the stock come to right above my limit, and the market makers just walk the stock down, take your order, and immediately walk it back up. Your limit stop loss order just set the bottom for the stock. Congratulations.

On a more liquid stock you can probably get away with entering the stop loss and just let it go.

Think of stop-loss in a broader context than a limit order entered at a broker site. The stop loss can take the form of an alert you set when the stock reaches a certain place, and you have a self-agreement that when that price level is triggered that you will go online, evaluate the situation, and then execute a sell order if required. If the stock traded to your trigger point on low volume and with no news, you might choose to wait until it decisively goes lower and then sell.

Rusty2

11th Nov '17

Hi Ken, Yes I agree you need to manage the risk, but stop losses are not the only way, I prefer alerts and reviews rather than stoplosses, I may place an odd stop loss on what I regard as risky shares but I generally don't now. I have diversified portfolio over about 50 shares in different areas of the world. Usually my opening trade on a share is about 1%, in UK and Europe I have 1 one share that's over 10% loss. 40 shares in a year, that have 10% loss or more does sound very high. I never do levered positions, I have some gold and an index short, about 50% cash at the moment due to high markets. So I'm quite cautious investor. I was going to sell more but some are still doing well and I'm finding more opportunities mainly in Europe but I was thinking about a cull and some profit taking, I have reduced my IQE (LON:IQE) by 2/3rds.

I will give one example of how a stop loss can you lose you money, this is on a share I have, I will simplify the numbers: buy 1,000 shares at £10, stop loss at £9, shares fall to £8.60, so you are out at £9, so you now have £9,000. I reviewed the shares at around £8.60 seemed to be no reason apart from some jitters in the US market with technology sector, so I did not sell, profits are growing strongly, all the recent forecasts have been positive, anyway after 3 months the shares are now £15.30, if I sold now I would have over £15,000, so 15,000 less 9,000 is £6,000 less in my portfolio. I think the question to ask yourself is if you did not own the shares would you buy them now at this price, if you would, does it make sense to sell them? Some shares I sell at no loss, I may find out something I don't like about the company or shares may have lost momentum, I don't wait for them to fall 10%. Paul Scott I have not read his interview but I think his problem was levered illiquid shares he could not sell, would a loss have saved him? I'm not sure it would. By the way he does not use stop losses now and often buys shares on dips or after falls, he has just bought Boohoo.Com (LON:BOO) and Fevertree Drinks (LON:FEVR). I have bought quite a few on falls, such as JD Sports Fashion (LON:JD.), Tristel (LON:TSTL), Burford Capital (LON:BUR) and £BXVP, in fact some of my better performing shares. JD Sports Fashion (LON:JD.) I sold after making about 40% in months, shares have now fallen back, would I buy now, no. But you are right it does have it's risks, you need to know the company, trust the management, I'm looking at quality companies and yes some don't work out like Next (LON:NXT) but overall it has worked for me. Many don't buy back after being stopped out, once bitten, twice shy, they fear they may lose again.

Did you see the Leon Boros interview? Don't think he uses stop losses either.

So in summary I don't use stoplosses but I review my shares regularly. Ones not performing well go on a sell watchlist, if they don't improve within a month or fall further I usually sell them. Of course some people don't have the time to do this, so I'm not saying don't use them, it depends on person and how they trade. For new investors, momentum traders and people who don't watch their shares they can be a good thing.

Thanks for your kind comments, it's good to have friends here.

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Stop Loss Remove the Fear

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About the Author

Ken Lowes

11 comments

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