Stop LossesHi All,
I am relatively a new member from the UK. I have a SIPP pension portfolio and some of the US stocks I hold have done well recently.
I am worried if and when there is a correction or even a crash I may lose out these gains. I am thinking of setting up stop losses for these shares. Is there a formula to work out the stop loss price? If not, how do you determine the stop loss?
Any advice is greatly appreciated.
Thanks,
Tim
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It’s really a judgement call. I like the logic of the stop loss triggers from TradeStops, which are basically set at the edge of historic volatility for that stock — if it moves down more than it has before, it triggers, to oversimplify. The academic research I remember (haven’t looked at anything recently) supported the idea of a 15-25% trailing stop loss, but only if you reinvest in something else with that money. There is no way to predict big movements, so make sure you don’t use stop losses as a way to sell out of everything without a plan to reinvest — a lot of people did that in 2008 and 2009 and never got comfortable enough to put their money back in the market, and being fully out of the market for a long time is, historically, a disaster for most people.
Maybe next time will be different, but that’s the basic idea — stop losses hep a bit in the short term, but only if you reinvest that money and don’t wait for some hypothetical perfect market setup or valuation to return (because when you’re feeling bruised about a loss, you’re likely to be extremely resistant to put that money back to work again). Being out of the market after a big collapse is terrible, because missing just a few of the best days — which often come during volatile times, not far from the bad days — means you give up most of the long term gains potential.
I use stops a little, to manage my emotional response as much as anything else, and because I do have otter investments I want to make, but I know that my portfolio would probably be larger if I had never used stops.
Selling is the hardest part of investing and the greatest way to remove long term profits. If you are new to investing and feel the need to “protect” gains then I find that stop losses are usually a trap. As Travis said in whole market turn downs (1999, 2008/9, 2020) they will destroy wealth for most because very few will get back in the market in a timely fashion. Google what happens if you miss the best 10, 20, 100 days of market returns. The threshold is less important than the reason for wanting to use them. The most effective way to make money is to have an investing style that matches you at the present time. Matching your risk tolerance, you financial position, your resiliency, your beliefs. Your conviction with stocks must be your own, ideas can come from anywhere (Travis has many great ideas for me) but the best way to make money is to find great companies you believe in and hold through the ups and downs. Don’t get me wrong I know you can theoretically make money by stopping out and reinvesting back in later at lower levels but in fact I can’t. To be honest I don’t know anyone who has personally been successful doing this. My biggest returns have come from companies that regularly suffer 25% plus drops and stopping out and buying in would look to have made me more in retrospect but we don’t invest in retrospect. So I stay strong, buy companies I believe in hold tight and if I have cash available buy more when they go down. For me and I can only speak for me I found that the only companies I was comfortable with putting stops on I wasn’t really a believer in the company. I had let people and services I respect convince me it was a good investment but I didn’t believe it. So whenever I consider a Stop Loss now I just sell the company and put the money to work somewhere else in companies I do believe in. My two cents.