Editor’s note: This article was first published in September 2010. Its statement that stop-loss orders are ‘lately widely recommended by brokers and analysts’ refers to 2010.
These days it is easy to invest in the stock market, even to the point of knowing for certain the most we stand to lose. That is what a stop-loss order does, and although it sounds wonderful, it is not all advantages.
A stop-loss is a conditional sell order in which the investor agrees in advance with their broker at what point they want to halt a share’s fall in value. In short, a stop-loss is there so that you don’t lose more than 2–5%.
So if you invest, say, €1,000, the stop-loss lets you make sure your loss is no greater than €100. Once the share falls to that minimum point, a sell order is sent to the stock market. That way the risk is limited.
However, while limiting losses is the advantage, in many cases having a stop-loss means investors miss out on considerable gains, because you have to bear in mind that shares go up, go down, go up again and go down again…
Lately it has been widely recommended by brokers and analysts, although personally I think a stop-loss is for someone placing a bet rather than making an investment, or for a beginner. It is very focused on the short term, and that is why this order makes us lose returns over the long term (in some cases).
On top of that, more and more people point to a further problem with stop-losses: it is as if the market had inside information, knowing that once a certain minimum price is reached those shares will be sold, which then triggers a new rise in the price.
All in all, if you have never invested and are thinking of doing so, this is without doubt a way to lose your fear of taking considerable losses.
Further reading
- Warren Buffett’s best quotes on investing
- Investing in warrants: definition
- What Arthur Rock analyzes before investing
Featured image: Ken Teegardin, CC BY-SA 2.0, via Flickr.
