Should You Have Stop-Loss Orders For Your Shares?

Stop-loss orders are standing orders to sell your shares when they fall to a certain price. These orders are designed to limit an investor’s loss in a stock, and can help to remove emotions from the equation when a share falls in price.

With the current market correction, it might sound wise to use stop-loss orders. However, I believe long-term investors would be better off not using such orders.

Inactivity does wonders

Whenever a stop-loss order is triggered, we incur a commission. To buy back the share at a lower price, we pay another commission. The more trading activity there is in our portfolio, the more our long-term returns get hurt.

In his 2005 letter to shareholders, billionaire investor Warren Buffett said:

“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”

To increase our returns, we have to decrease our motion. That means we have to stop jumping in and out of the market.

Inadvertent selling of shares

Sometimes, a stop-loss order can be hit due to non-company specific events, and at a price that is much lower than the price you want to sell your shares at.

On May 6 2010, the US stock market saw a “flash crash”, where US stock market and futures indices nose-dived inexplicably, plummeting 10% in a matter of minutes. Some blue-chip stocks even had their share prices in the cents-range briefly, only to recover most of the lost ground before the market closed for the day.

If we had a stop-loss order back then, the order could be filled at the next available price, which could be much lower than the stop-loss price we had set.

Price falls are opportunities to buy more

For long-term investors, falling stock prices are an opportunity to buy more shares cheaply. You could argue that we can limit our losses by using a stop-loss order and buying back shares later at a cheaper price, unlike simply buying and holding, which would cause paper losses. But do remember that we will incur unnecessary commissions by frequent-buying-and-selling, and that it is hard to time the market.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.