Danger Of Using "Stop Loss"

[CityFarmer]

While value investors trumpet MOS, it should be noted that in investing, the number ONE rule is always 'Don't Lose Money'.

To the person who had 30% of his portfolio vested in CMZ when Glaucus Research released its short-sell report on 26th Aug 2013, he would have wish that he had some kind of stop-loss mechanism in place, by the time CMZ halted trading of its shares. SMOL summed it up very nicely - it is all about risk-management and 'stop loss' is one of this. Risk management is about answering the question of 'What if I am wrong?', MOS addresses this question partially but what about 'What if i am TOTALLY wrong?'. Collectively, i suspect value investors are over-confident of their contrarian ability.

That said, price-alone stop losses are not the value investor's cup of tea, because again, value investors pride themselves in paying 50cents for a dollar worth of goods. But i would still continue to implore all to look back in the recent past (eg.2008) and ask, how do i successfully integrate a stop-loss mechanism that fits my temperament/style to reduce the damage done, especially for those who are always 100% vested in the market.

Price-alone stop losses are counter-productive for a value investing strategy. Having said so, it doesn't mean value investors are overly confident, and will never make mistakes. There are stop losses used, but not price-base, but value-base.

Once a vested stock's value drifts too far lower from its price, either due to price hike, fundamental worsen or mistake made, a "value-base stop-losses" should be triggered.

I am always 100% vested or close to it. I had triggered quite a few "value-base stop-losses" in the last few years alone.

[Temperament]

One thing about STOP LOSS is that we are opening data collectively available for people to manipulate.
Someone can have a tool to capture all the stop loss points, and theoretically engineer a collapse to profit from it.

If this can be done, it can happen !

In fact the article pointed out this danger. i think it's real. What with our ultra super fast computer and algorithm is as easy as ABC for the computer specialist.
Maybe from times to times you see a "flash crash" without explanation is one of those times.

[Jared Seah]

25 other S-chips have gone to zero. This CMZ is 1 out of 26 to have recovered.

If you ask shareholders of the 25 failed S-chips, you will get one opinion.

If you ask shareholders of CMZ, you will get another opinion.


Of course can don't use stop-loss. It's just one of many risk management tools available to us.

It's nice to see those who don't use stop-loss share their alternative risk management techniques.

It's painfully obvious who practice no risk management running around like headless chicken in this forum when the market goes against their positions.

While those that have risk management in place calmly execute their Plan B

[Breadman25]

There is 1 thing i dont understand about this auto "stop loss". Suppose the price drop drastically and trigger a auto stop loss, and the computer sell your stock for you. Isnt it that to sell your shares, there must be a buyer?? During a big crash, wont the sell volume be much higher than the buy volume?? If there come a time when all the buyer already bought their shares, wont your stock still at the "waiting to sell" stage??

[Jared Seah]

Breadman25,

There are 2 kinds of stop-loss orders.

Let's say we have a stock bought at $1.00.

If our "uncle point" is a 20% loss, then we set the stop-loss at $0.80

1) Stop-loss $0.80 point triggers MARKET order. This is the kind of stop-loss orders that the author of the article is warning against.

This kind of stop-loss means you want to get out of the position no matter what, at WHATEVER price!

So the price you've sold could be anyway from $0.80 to $0.01 - depending on the buy queue. You have zero control on the sell price.

If you look at CMZ or the 3 recent designated stocks trade history/charts, you can see there will be bottom-fishers and short-sellers covering to take the opposite side of the fear trade. These are the "brave" speculators that doubled their money if they were right.


2) Stop-loss $0.80 point triggers LIMIT order - You have to specify your limit sell price. Let's say you limit it to $.75

That means your sell price will range from $0.80 to $0.75 max. You control at what price you willing to sell; not at any price.

The drawback like you've mentioned is that the sell down can be so fierce that your stop-loss limit order never gets done by end of the day.

You are queuing to sell at $0.75 while others are selling at $0.50!

At day close, the closing price can be down to $0.10 to use an extreme example like the 3 designated stocks.

You are now still stuck with your position with 90% unrealised loss... even though your stop-loss limit order was triggered; it never got done.


So there!

Market orders are there for a reason. Like water, it can float; it can drown. Use with care.

It's never the tools; it's the user.

[Clement]

Breadman25,

There are 2 kinds of stop-loss orders.

Let's say we have a stock bought at $1.00.

If our "uncle point" is a 20% loss, then we set the stop-loss at $0.80

1) Stop-loss $0.80 point triggers MARKET order. This is the kind of stop-loss orders that the author of the article is warning against.

This kind of stop-loss means you want to get out of the position no matter what, at WHATEVER price!

So the price you've sold could be anyway from $0.80 to $0.01 - depending on the buy queue. You have zero control on the sell price.

If you look at CMZ or the 3 recent designated stocks trade history/charts, you can see there will be bottom-fishers and short-sellers covering to take the opposite side of the fear trade. These are the "brave" speculators that doubled their money if they were right.


2) Stop-loss $0.80 point triggers LIMIT order - You have to specify your limit sell price. Let's say you limit it to $.75

That means your sell price will range from $0.80 to $0.75 max. You control at what price you willing to sell; not at any price.

The drawback like you've mentioned is that the sell down can be so fierce that your stop-loss limit order never gets done by end of the day.

You are queuing to sell at $0.75 while others are selling at $0.50!

At day close, the closing price can be down to $0.10 to use an extreme example like the 3 designated stocks.

You are now still stuck with your position with 90% unrealised loss... even though your stop-loss limit order was triggered; it never got done.


So there!

Market orders are there for a reason. Like water, it can float; it can drown. Use with care.

It's never the tools; it's the user.

I think stop losses can be used only for stocks with reasonable liquidity. I have been stopped out by a wide bid ask spread, though I'm unsure whether it's the software using bid prices to trigger or a one lot trader triggering it. For illiquid stocks with frequent 3 or more tick bid ask spreads, I think it's better to just trust your own discipline. I don't see the point in putting a stop that is say 20% from the current price, just to avoid being played out, as the chances of really selling at the bottom are too high.

[Jared Seah]

Of course Clement.

The stop-loss point will be dependent on many other factors - depending on the vehicle chosen. It's never one size fits all.

The bid-offer spread is one reason why penny stocks are more "expensive" when it comes to transaction costs. But speculators love them as 1 to 2 bids already can make 3-5%!

20% is just for illustration since this is an investors forum. To recover from a 20% loss we just need a 25% win the next time round. Very achievable.

If using 50% margin of safety (is this realistic?), that means these value investors must be sitting on lots of 2 baggers now or as part of their track record. Their stop-loss point can be 50% to prevent a winning position from swinging to a loss

Traders use other "stricter" rules like never risking 2% of our total portfolio value in a single position. Traders are less philosophical.

No chips; no honey.

[Clement]

Of course Clement.

The stop-loss point will be dependent on many other factors - depending on the vehicle chosen. It's never one size fits all.

The bid-offer spread is one reason why penny stocks are more "expensive" when it comes to transaction costs. But speculators love them as 1 to 2 bids already can make 3-5%!

20% is just for illustration since this is an investors forum. To recover from a 20% loss we just need a 25% win the next time round.

If using 50% margin of safety (is this realistic?), that means these value investors must be sitting on lots of 2 baggers now or as part of their track record. That mans their stop-loss point can be 50%

Traders use other "stricter" rules like never risking 2% of our total portfolio value in a single position. Traders are less philosophical.

Well, I meant putting a not "tight" stop loss just to avoid computer interference. I doubt stop losses help with anything if you set the tolerable loss at above 10%. Anyways, that episode was during a time when stocks traded in different tick sizes so it might be less costly today even if I do get faked out. I sometimes employ leverage so i like to adopt the paranoid approach to risk management.

[Temperament]

Of course Clement.

The stop-loss point will be dependent on many other factors - depending on the vehicle chosen. It's never one size fits all.

The bid-offer spread is one reason why penny stocks are more "expensive" when it comes to transaction costs. But speculators love them as 1 to 2 bids already can make 3-5%!

20% is just for illustration since this is an investors forum. To recover from a 20% loss we just need a 25% win the next time round. Very achievable.

If using 50% margin of safety (is this realistic?), that means these value investors must be sitting on lots of 2 baggers now or as part of their track record. Their stop-loss point can be 50% to prevent a winning position from swinging to a loss

Traders use other "stricter" rules like never risking 2% of our total portfolio value in a single position. Traders are less philosophical.

No chips; no honey.

So Stop Loss can be used to protect your gain too. In this case, this is call "Progressive Stop Loss".
When you want to sell, of course you want to sell at the highest price possible. That is provided the market doesn't suddenly crashes. i have said i use progressive limit price instead as i am very greedy.

[Clement]

Of course Clement.

The stop-loss point will be dependent on many other factors - depending on the vehicle chosen. It's never one size fits all.

The bid-offer spread is one reason why penny stocks are more "expensive" when it comes to transaction costs. But speculators love them as 1 to 2 bids already can make 3-5%!

20% is just for illustration since this is an investors forum. To recover from a 20% loss we just need a 25% win the next time round. Very achievable.

If using 50% margin of safety (is this realistic?), that means these value investors must be sitting on lots of 2 baggers now or as part of their track record. Their stop-loss point can be 50% to prevent a winning position from swinging to a loss

Traders use other "stricter" rules like never risking 2% of our total portfolio value in a single position. Traders are less philosophical.

No chips; no honey.

So Stop Loss can be used to protect your gain too. In this case, this is call "Progressive Stop Loss".
When you want to sell, of course you want to sell at the highest price possible. That is provided the market doesn't suddenly crashes. i have said i use progressive limit price instead as i am very greedy.

It really depends on why you want to sell. If it is because you see a better opportunity or need cash, then wouldn't it be best to sell immediately? If it is because of lack of margin of safety, the a trailing stop works while you look into whether you were too pessimistic in your calculations.