Should I use a stop loss?

Wednesday, 21st November 2018 09:52 - by Rajan Dhall

Longer-term investors tend not to use orders to protect their losses as they see the money invested as their risk. I both trade (short-term) and invest in stocks (long-term) so I can see the argument against them both.

Protecting yourself against massive drawdowns is key at the moment. Especially as global sentiment in equity markets remains in the balance and one of the best ways to protect yourself is to use stop orders. Let me be clear about one thing stop orders will not limit your losses if a company gaps down at the open. They will just find the next best price and close your position. 

So what's the point? Account management and risk control can be the be all and end all for survival. At the beginning of a trade I am sure you think about how much you could lose, but I bet your thinking more about how much you can gain! Lets take a look at a simple example of risk control:

let's say you take five trades, two of them lose and three of them win but you have no stop - who is to say that those losers don't take out the total gain from the three winning trades?

Now let's say you take a more methodical approach and you have five trades. Two with a stop loss of £1000 per trade and three with a target return of £3000 per trade or even open targets.

Obviously, the win ratio is the most important thing here but you could be profitable with only 35% of winning trades depending on your targets.

You can see where I am going with this now and it only gets more prevalent the more companies you are invested in or the more positions you have. 

Sure some unrealised losses will come back but over the longer-term but this is how accounts get ruined, its in the hope that the price will return. It comes down to short term pain vs long term gain.

Moving on, I also believe it is a good idea to trail your stop losses in winning position but I will save that for another post. I hope you found this information useful. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.