We have just read an article on a responsible website which argues that using stop-losses “will strangle your returns”. Such is our despair at reading such dangerous nonsense that we rush to write this blog lest anyone be suckered into believing such arrant nonsense.
The argument used is that “a stop-loss doesn’t just limit a loss, it captures it”. What a brilliant piece of deduction that is – of course it captures the (small) loss – that is exactly what it is supposed to do. What happens when no stop loss is used is that the potential loss will grow and grow until it reaches unbearable proportions for the investor. Why would anyone want to sit idly by and watch their investment(s) continue to fall down a slippery slope? But that is exactly what can happen – and does happen – when the investor has no reference price at which to exit his loss making trade.
The refusal to use a stop-loss is the hollow reasoning of the ‘buy and hold’ investment adviser; why take a small loss early on when you can hold on (for years?) and wait for your stock to recover and go on to make a profit? – sounds a logical argument for someone who knows no better – but how is the investor going to feel as he watches his shares fall in value month after month in a ‘bear’ market such as we have recently experienced? The answer to that is well known and well documented; the investor hangs on in hope, hope that each lower price will be the final turning point until, in the end, all hope is lost and he can stand the disappointment and accumulated losses no longer so he closes his positions in a final expession of sheer exhaustion and disallusionment.
This spurious article then went on to suggest that to protect and preserve your capital all you have to do is achieve a “modest diversification”. How, we wonder, does this suggestion (which we consider as subversively dangerous for the average investor) hold up when some 90% of shares listed on the stock market (London and New York) all suffer a synchronised fall (and some of them losing 90% of their value in a few months)?
Let’s look at just one popular share, Royal Bank of Scotland (RBS) – something of a favourite with the ‘buy and hold’ brigade:
Had you bought RBS shares back in, say, 1st June 2001 at about 540p where is the value and what is the point of holding those shares for the last 8 years? -
Click on chart to enlarge.
As a holder of RBS shares you would have been quite happy when the price got up to the 700p area a couple of times but what now that it is at 38p?!
And as for the argument that you would have had the dividend income every year – well just work out what you would have earned in interest had you left your money in the bank. And you would still have 100% of your capital. A stop-loss would have got you out with a small loss and left you with the majority of your capital to re-invest.
Finally, the last empty boast of the ‘buy and hold’ proponent; If the share was good value at 600p “it is even better value after a price fall” – at 400p perhaps? Is it then even better value again at 250p? And it must be stupendous value then at its current price of 38p!! The fact that it could halve again and fall to its low of 10p just gives the lie to that silly, dangerous ‘value’ argument.
So, dear reader, please do not be beguiled into buying and holding and do, for the security of your capital (or most of it) and for your ability to sleep well - do use stop-losses.
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