Some Thoughts On Using Stop Losses

by Olivier on May 8, 2010

It goes without saying I am not exactly happy with the development the KIV.V – Kivalliq Energy chart took. Then again, that’s what stops are for. When I originally bought KIV.V and put in my stop loss, it was at a price level I deemed should never have been breached. Put another way, price breaching a certain level invalidates my original assumption. Does that mean the stock is not worth monitoring anymore? Of course not, but the market told me either one or more of the following things:

  • My timing was wrong.
  • My sector analysis was wrong.
  • My overall market assessment was wrong.
  • etc.

My point is, stops are used to protect you in case something gets out of control. You have to keep losses under control and not let them turn into huge devastating losses. It really doesn’t matter that much if you use mental stop losses or hard stops. The key is to be disciplined and honor your stops. If you don’t and start rationalizing holding on to your position you are not a professional trader. Simple as that. It takes mental fortitude and lots of strength to sell when you use mental stop losses. Putting in hard stops removes the pressure and eliminates the risk of second guessing yourself.

Of course there’s always the risk of market makers running stop losses. But that’s simply part of the business. Some have asked me to write more about stops and if it wasn’t too dangerous putting in hard sell stops that turn into market sell orders with stocks traded on Canadian Exchanges. That’s a good question. Risk is obviously higher the more illiquid a stock is. No doubt about that. One suggestion was to put in stop limit sell orders instead. My take is, that putting in stop limit sell stop orders simply defeats the purpose of a stop loss. It turns into a sell limit order and your order might not get executed if the stocks just keeps falling. The reason for using stop losses is to take you out at a predetermined price level. No questions asked. Stops cannot protect you against gap downs no matter what type of stop you use.

The important thing to keep in mind here is that you accept getting stopped out no matter what. Being out of a stock is more important than knowing the reasons why you got stopped out or trying to save a few extra pennies. At times your orders will be executed below the level you actually placed your stop loss at. That’s simply the cost of doing business.

Be willing to pay the price, otherwise you will end up doing the buy and hold thing. You might be lucky for a few months or even a few years. Eventually you are exposing yourself to holding on to the one stock that won’t recover. You are then running the risk of relying on hope instead of objective analysis. Loss of mental energy and mental capital ensues. Your goal is to be in control of your position. Not the other way round.

Conclusion:

What I should have done better is the following: The stock shot right out of the gate when I initiated the position. At the peak my position was up a bit more than 20%. I let a winning trade turn into a losing trade. When a trade is up more than 20 – 25% that is something I should not let happen. Something I need to pay more attention to going forward.

My overall market exposure is now rather low. The name of the game is to find and get exposure to new opportunities.

Advice in old age is foolish; for what can be more absurd than to increase our provisions for the road the nearer we approach to our journey’s end. – Marcus Tullius Cicero

My public list with all my charts can be viewed here:
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID2791469

Have a great weekend!

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