The Little Book of Market Myths: How to Profit by Avoiding the Investing Mistakes Everyone Else Makes

Chapter Eleven

Stop-Losses Stop Losses

“A stop-loss can stop your losses!”

Even the name stop-loss sounds good. Who doesn’t want to stop losses? Except, stop-losses don’t do what people want them to. Instead, they tend to trigger taxable events and more transaction fees. And they more often stop gains than they do losses—on average over the long-term, they’re a money loser. Don’t buy into this costly myth.

Stop-losses come and go in popularity. You tend not to hear much about them in the latter stages of a bull market. Sir John Templeton famously said, “Bull markets are born in pessimism, grow on skepticism, mature on optimism and die of euphoria.” Stop-losses are mostly a pessimism–skepticism game, though they have adherents no matter the market cycle. They tend to appeal to people who think downside volatility is bad but upside volatility isn’t volatility at all. But as discussed in Chapter 4, you can’t get the upside without the downside.

The Stop-Loss Mechanics

For the uninitiated, a stop-loss is some mechanical methodology, like an order placed with a broker, to automatically sell a stock (or bond, exchange-traded fund [ETF], mutual fund, the whole market, whatever) when it falls a certain amount.

That amount is up to you! There’s no “right” amount for a stop loss (mostly because there’s no level proven to improve long-term performance). Typically, folks tend to pick round numbers like 10% or 15% or 20% lower than their purchase price. No reason—people just like round numbers. ...