Just stop it with stop loss orders

I went to cash right before the pandemic (good) but then stayed out of the market during the big (bad) market rally. I started buying again last fall and now I invest two thirds of the entire stock in high quality dividend stocks. This is my question: When I buy a stock, should I pay more attention to the stop loss function? If so, what guidelines would you suggest?

Here’s the thing about selling when things hit the fan: you might save yourself some losses down the road, but it takes an iron stomach to get back. Most people wait until they see clear signs that the crisis is over, and at what time prices have actually recovered. I probably don’t need to be reminded – but I will anyway – that holding great companies through good times and bad is a tried-and-true recipe for investing success.

Which brings us to your question about stop loss orders. When you place a stop loss order, you are instructing your broker to sell the stock when the market price drops to a certain level. Unless you specify otherwise, the stop loss order is converted into a market order, which means the broker will sell the shares at the best available price.

I can think of a lot of situations where a stop loss order might come in handy. Shopify Inc. (SHOP), which has fallen about 80 percent over the past seven months, is springing to mind. So did Netflix Inc. (NFLX) and Canopy Growth Corp. (WEED) and Coinbase Global Inc. (COIN), all of which were amazing busts.

Aside from the crash, these stocks have one more thing in common: they are all highly speculative, and they pay no dividends. Moreover, their prices tend to be highly volatile. So, if you’re investing in these types of high-risk stocks (which I don’t recommend, unless you hold them through an exchange-traded fund), your stop-loss might be worth considering.

However, you said you’re buying “high quality dividend stock”, by which I assume you mean things like banks, utilities, telecommunications, energy producers, REITs. I own these types of stocks personally and in the Yield Hog Dividend Growth Portfolio Model, I can tell you that I have never used stop loss orders with them.

why not? Because a stop loss order goes against the buy and hold philosophy. If you own conservative, reasonably-valued companies with increasing revenues, profits, and profits, the only thing a stop-loss order will accomplish is sink your shares at the worst possible time.

Let me illustrate using some actual historical numbers.

Let’s say you bought 500 shares of Royal Bank of Canada (RY) when they were trading at $100 in the late summer of 2019. I probably thought at the time, “I’m going to use it safely and place a stop loss order for $80 because I want to protect myself if it happens.” bad thing “.

Sure enough, six months later, a once-in-a-century global pandemic and market eruption have arrived. Whew! It’s good that you had the foresight to enter this stop loss order, right?

wrong – wrong – wronged On March 12, 2020 – the day after the World Health Organization announced the outbreak of the COVID-19 pandemic – Royal Bank shares fell more than 10 percent to $78.61, down from the previous close of $87.87. Since the price has fallen below the $80 stop loss limit during the day, your broker will sell your shares automatically.

But guess what happened next? Royal Bank stock jumped nearly 15 per cent the next day. You would have seen the bouncing off the sidelines, perhaps with tears in your eyes, because all you were going to accomplish was sell a big stock at a poor price.

If you are a long-term investor in a big business, rather than someone who gambles on speculative stocks, then stop-loss orders are not your friend.

in his book, refuteUS billionaire Ken Fisher says small investors should stay away from stop-loss orders – just as most institutional investors do – because they raise trading commissions, tax and don’t get what people think they are doing.

“It would be more accurate to call them ‘stop winnings,'” says Mr. Fisher. “They are just expensive security hoods for nervous investors. Except for voids they do no real harm, while stop-losses are a small, insidious scam.”

So, instead of trying to stop paper losses, you should learn to accept them as a completely natural and inevitable part of investing. Your wallet will thank you in the long run.

Email your questions to jheinzl@globeandmail.com. I can’t personally reply to emails but I chose some questions to answer in my column.

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