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Why a stop loss can kick you when you're down

by , 02 June 2014

Investing in shares comes with risks. And to take care of the downside risk, stop losses are a must. You decide how much of your initial investment you're prepared to lose and set your stop loss at that. Then if the share price falls and hits that level, you sell. Simple as that. But using stop losses also comes with its issues. Read on to find out more…


Setting a stop loss level

Using a stop loss is a great way for you to remove an ailing company from your investment portfolio. Stop losses highlight poor performers, allowing you to clear them out to make room for replacements.

Setting your stop loss levels is of personal preference. For instance, if you have a high tolerance for risk, you may set wider stops than someone more risk averse.

And it’s worth using different stop loss strategies for different types of shares. For example, you wouldn’t expect a large-cap to be very volatile so you could run a tighter stop loss on that compared with a penny stock.

For instance you pay 100c for a share. If it’s a blue chip share, you might set your stop loss at 90c. But if it’s a volatile penny stock, you might set your stop loss at 75c.

As much as there are numerous advantages to using a stop loss, it doesn’t come without its downside…

When a stop loss turns against you

As with any risk management strategy, a stop loss isn’t flawless, David Thornton in Penny Sleuth explains.

For example, you could sell your shares when the market dips, just before it takes a big swing higher. And you miss out. You sell your shares and bank a loss.

Of course, there’s nothing you can do about this kind of thing happening. You’ll be kicking yourself: Losing money on the shares and losing money you could have made had you not sold your shares.

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You could try and overcome this by reviewing the share before you sell. Ask yourself if the share’s trend has changed? If not, hold on. But if this kind of reasoning is going to result in you never selling a share, best to stick with a strict sell if it hits its stop loss policy.

So there you have it, why a stop loss can kick you when you’re down.



Why a stop loss can kick you when you're down
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