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Stop Loss Order – Are They Right For You?

Bob Crane
 


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I have been trading stocks now for over ten years and have never used a stop-loss order. There are several opinions as to whether you should use a stop-loss order or not but it comes down to your personal preference and trading style. If you are the type of trader or stock investor that takes long positions it really doesn’t matter just as long as you have quality companies in your portfolio.

During my years trading stocks I have set-up several accounts where I only paper trade to try out new techniques. The dummy portfolios range from tech stocks to under three dollar stocks. I also have dummy portfolios set-up for the various sectors that include the ETF’s for those sectors along with stocks of the most prominent companies in the sector.

The dummy portfolios where I have lost the most “money" is the three dollar and under stocks. It seems that the smallest companies where you could really make some money if they took off provide you with an opportunity to lose the most also. The stocks may seem cheap but if you look deep into the fundamentals of the company you will see that they aren’t really cheap at all. They just appear cheap because the stock is only three dollars. For someone who wants to trade those cheap stocks a stop-loss order would probably benefit you because if the economy itself doesn’t cause the prices of the cheap stock to go down the company usually has a secondary offering to raise cash that drives the stock lower.

If you are trading large high-quality companies you could actually be worse off from using a stop-loss. Let’s say that you had a hundred shares of XYZ company that you paid thirty three dollars per share for and you place a stop loss order to exit the trade if the price drops to thirty two dollars. Ok, so you are two days into owning your one hundred shares of XYZ corporation at thirty three dollars and it has already gone up five percent so you are making money on it then out of no where comes a newsflash that a terrorist may have a bomb in a key government building and a bomb squad is on the way. . etc. Once the news hits the airwaves the stock market takes a big tumble and your shares of XYZ company drop to thirty-one dollars for one second and your stop-loss order is executed. One hour later the news comes back on and says that the terrorist threat was a hoax it was only someone working on the elevators in the building that scared someone into calling 911.

Three hours after you were taken out of your trade the price of XYZ shares go to thirty four dollars per share and continues climbing due to good news that the company just announced about a new product it is bringing to the marketplace. In that example you were whipsawed out of your position and turned what would have been a winning trade into a loser. In those cases instead of using a stop loss it would have been better to buy more shares of XYZ company as they went on sale if only briefly.

If you have a really profitable position in a stock and you are concerned about the recent quarters earnings report you may be better off just selling your position, but the next best thing in that case would be a stop-loss order to preserve some of your profits should the earnings news come out bad.

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