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Stop Loss is Silly and Good (by moolahNbeyond.com)

You will realize that I absolutely dislike trading (buying and selling within a short time frame) as you read more posts about my investment philosophy.

Here’s another reason why I think some trading tactics would lose you money than make you money. Stop Loss – its when the stock drops below a certain price point or ’support’ level, one is encouraged to sell the stock to flee to ’safety’ and retain his/her capital as the future prospect of the stock price is uncertain. This sounds reasonable but it is nonsense! Traders’ justification for having a stop loss set up is for a safety net. If the stock market crushes, they would be able to get out and hold cash until things look clearer. A lot of people buy into this idea but if you think about it, how can you make money when you sell stock at a low price?

Value investors shop for stocks that are ON SALE when prices look attractive, they don’t cut their losses or profits because they are not the panic type. They have done their homework on the company and they understand that the fluctuation is caused by market panic and everything is safe and sound within the company. Unless things are seriously wrong with the company and you don’t believe it is going to improve. If that is not the case, you should not sell the stock! That’s why it is silly to have a stop loss.

But how is a stop loss good at the same time? Well, since a lot of funds and traders are forced to have this stop loss function in place for their reasons, when a market suddenly drops drastically, computer programs will automatically start selling your holdings for you. And when drop triggered a sell and a sell triggered a drop, this cycle makes the market drops even more than it should. That’s one of the reasons why this led to unwanted selling and collapsed the system within minutes like what happened on May 6th when the marketed dropped 10% in a few minutes.

The May 6th crash was extreme but it was not the first time. When the market crashed in 1987, the magnitude of the drop was magnified by the brilliant idea of ’stop loss’. With the help of such function, a lot of value investors were able to pick up stocks at a better discount. That’s why it is good :)

By being calm and rational, not only does it clear your mind but helps you make better decisions. Don’t join the group of panic sellers! 

Disclosure: Long Apple