With investing, I’m not sure there is another industry where you can do so many irrational things and still keep your clients or your job. Stop loss orders are extremely common technique used money managers as a way of limiting losses, whereby the stock is sold when it falls below a minimum price level.
Even as a kid this never made sense to me. If you believe the value of a stock is $10 and you buy at $7 why would you put a stop loss at $5? All else equal, that’s exactly when you would want to buy more! Nevertheless, I hear about stop losses all the time, especially by the ‘experts’ on BNN (Canada’s CNBC).
Stop losses expose the investor’s true intention, they are looking to rent the stock, not buy it.
Of course, the last word on stop losses goes to Buffett who discussed it in his 1987 letter:
“After buying a farm, would a rational owner next order his real estate agent to start selling off pieces of it whenever a neighboring property was sold at a lower price? Or would you sell your house to whatever bidder was available at 9:31 on some morning merely because at 9:30 a similar house sold for less than it would have bought on the previous day?”
In my opinion, if you are using stop losses you are not investing, you are speculating.
Tags: value investing