Where to place the Stop Loss Level

Timing of the Shrewd

As an individual, I feel it is important to have an exit criteria as nobody knows when a really severe fall is going to occur from which it may take years rather than months to recover. Some individuals may be prepared to accept this, though I imagine they are in the minority...

How many of us have said I'll wait until it reaches such a price on the upside to recover some of my losses and then I'll sell when in fact the share price dives further? We all want to run gainers and cut losers but without some form of discipline you can risk losses mounting up as far as I am concerned.

Do you really have the time to monitor stocks closely on a daily basis? If you have a full-time job other than trading then I very much doubt that you can, in which case a stop loss (and even better a trailing stop) is essential if you want to limit your losses and protect your profits. The stop loss issue is an interesting one, and I don't believe there is a definitive answer. Rather we should apply different strategies depending on the stock.

Now for large cap stocks, check on the share price graph and see how volatile they are, and tailor your stop loss to accommodate that volatility. For banks, financial stocks, utilities I would apply a 15% stop loss to start with. Every time a share hits a new high, re-calculate and/or reset your stop loss. Once you start to build up a good profit, say 50%, then you can start to tighten up the stop loss, i.e. from 15% to 10%, and once you've doubled your price cut it again to say 5%. You should know your blue chip stocks sufficiently well to be able to decide when to get out- i.e. there is a regular selling of shares by directors, i.e. Chairman CEO and FD, or if the institutions are unloading in a big way, or news of a major competitor entering the field, a heavy increase in borrowings or where the interest cover is say below 2, i.e. they can only cover their interest charges twice from their operating profits or if dividends are being reduced, or if earnings are likely to decline because of say a fire in a mine, or late delivery to the States (Turbogenset's problem- they were hit with heavy penalty clauses by their Californian customers), or if their gearing becomes excessive, or if the share price falls below the 200 day Moving average, as in the case of Mears, then they became a sell.

On stocks in AIM, Small Caps.etc, stocks subject to a greater risk level I apply an initial stop loss of 20-25%. For instance my stop loss on DDD is 50% but I happen to believe that in the medium-long term they will prove to be a winner, just like Oxford Biomedica. But the stop loss has to be flexible enough to allow that share to grow and generate the profits you seek. Once DDD becomes profitable you can cut the stop loss to 25%. As the profits grow ratchet up the stop loss OK?

Greed, fear and panic are common pitfalls for retail investors with the added leverage in spread betting

OK, so you have your stop loss figures in place but let's assume that there is a sudden correction in the markets, like the 12% correction that hit us last June - most of my stocks fell out of bed. Now this is where you need a mechanism in place to ensure that you keep them - I prefer to have a buy back price, i.e. a price that allows you to buy your holdings back at say 10-15% less than the stop loss, but subject to a quick evaluation of their fundamentals; only and only if the fundamentals remain strong and unchanged should you buy back in! Otherwise, if for example the executive directors are selling large chunks, or perhaps a key patent is being challenged, or one of the acquired companies isn't performing as you had expected, or the CEO is under investigation, then forget it and move on.

The only exception to this rule, and that only applies if I have the time to monitor a share very closely on a day to day basis, is a company with a market capitalization of over £750 million. Then I watch the chart using 50 day and 200 day Moving averages and Bollinger Bands - if I see the share price falling back to the 50 day line that puts me on alert- ask yourself why and don't be afraid to ring the company. For the bigger companies they usually employ a shareholders representative, but for smaller companies ask to speak to the financial director, sometimes you will get the CEO, ring early at 8.30, normally you will find them very helpful but if they are obtuse, or keep referring you to the company website, then stay alert; look in your papers, run the problem through Google and learn what the market is saying, read the FT, read, read and read very soon the reason comes to light. As a precaution you can also cut the stop loss further back to 5% until you are sure. Don't be put off by individual directors selling shares and picking up the odd half million - these people need some extra cash to fund the lavish lifestyles they often lead i.e. they need cash for second homes, money to pay school fees, money to set their kids up in business, read the notes attached to the accounts, the reasons for the sale(s) are often stated.


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