The problem with stop-loss orders

If you’ve ever owned a very old car, you may have experienced the giddy feeling of pressing down on the brake pedal and having it go straight to the floor. Brakes are Good Things.

modeltFor investors, one form of emergency brake is the stop-loss order. Basically, you tell your broker to sell a stock (or mutual fund) if it declines below a certain level. It’s convenient, in that you don’t have to monitor the stock all the time, and generally sensible. If your stock is down, say, 11% from where you bought it, it’s probably best to take your losses and wait for a better time to buy the stock.

So what’s the downside? Suppose you’d put in a stop-loss order for Micron at $14.50 last week. The stock closed at $14.53 yesterday. Today, however, the stock opened at $13.81. What price did you get? $13.81. A stop-loss order simply means that your broker will try to sell the stock at the best price below below your stop. If the stock gaps below your price, you get the first bid below your stop order  — in this case, $13.81.

All the more galling, of course, is that fact that Micron quickly regained its mojo, and, at this writing, is trading for $14.93.

By and large, it’s better to have a stop-loss order on a position than not. (Many companies will now let you put in a stop-loss order at a set percentage below its most recent closing high — a nice feature if you want to preserve gains). Just don’t think that it will slam on the brakes just in the nick of time.

One observation about yesterday’s selloff:  It was big, it was bad. But it was a piker compared to Black Monday in 1987, which saw the Dow fall 22.61% in a single day. Had it been of similar magnitude, we’d be contemplating a 3,723-point loss in the Dow this morning.

 

 

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