Article researched and written for Fill ya Boots! 

by Les Fearn

You may be wondering why Fill ya Boots! would want to write an article about the importance of a stop-loss system – after all, many of the tips we give on this web site are long-term risers (fortunately), but no one in this world is perfect, nor do we claim to be. Whether you are a beginner at share-dealing, or have been trading for many years, the ups and downs of the stock market are as unpredictable as the British weather. 

So why use a stop-loss system ? Many people will just say to you “buy when the price is low, sell when the price is high” – if only it was that simple.  After hours of research into a stock which sees a steady increase in its share price, and then falls southwards, how do you determine what price to sell at ?  Well, we have the answers……  

In times of a stock market crash, like that in October 1987, the use of a stop loss system would have been the ideal tool for investors who saw their prices both in the UK and US fall dramatically.  Some commentators believe we are heading down a similar path in 2000.  With Telecoms & Technology stocks at all time highs, and what some see as over-ramping by people on bulletin boards and articles in the press, now is perhaps a good time to tell you about what the system is and how you can implement one yourself with very little effort. 

What is a stop-loss system 

In simple terms, a ‘stop-loss’ is a predetermined price at which you will sell a share if it falls through that price.  Its main aim is to enhance your profits (by moving the stop-loss higher as the price increases) and limit your losses.   You should bear in mind that this should have no reflection on the fundamental reasons for investing in the first place though.  

“It allows you to choose how much you can afford to lose.  It stops you persuading yourself to hang on, on the hope of a recovery which may never come”

(Michael Walters)   

As a simple illustration, if you had bought Media Invest shares at 14p on 10th December 1999, by 18th January 2000 these were selling at 92p.  Setting a stop loss of 80p would of ensured you had sold your shares at 80p and kept a healthy profit.  The following day the share price fell to around 55p, effectively wiping out 42p per share if you had sold them.

It is imperative that you keep to your decision on selling though, especially when you are seeing falls in a share price, otherwise the whole exercise is pointless.  In one sense, the ‘selling’ decision is made for you and you are not at risk of other people persuading you not to sell.

It can be tempting to ignore your stop-loss.  Although a share price has dropped, you may be convinced that it will soon rise again.  You may not like to admit that you made a mistake buying the shares in the first place.  Sometimes you will be disappointed that the price immediately starts to rise again, but in the same context, when a share falls, you will be delighted about the money you did not lose.  If you are really confident about a particular company (and you should be if you are investing in them), you can always buy the share back when it does start to rise again – often at a lower price than when you sold.

Rules when using a stop-loss system

·         The first rule to understand, is that shares are for selling as well as buying

·         Set a stop loss on all your shares at a reasonable level – 10% to 25% below the current selling price is recommended, depending on the volatility of the share and the sector it operates in.

·         When you see an increase in share prices, move your stop-loss up accordingly

·         NEVER lower the stop loss price (the idea is to limit losses)

·         Don’t be distraught if a share goes through your stop loss and then increases dramatically – even top tipsters like Tom Winnifrith and Michael Walters kick themselves when this happens

·         Remember the system will not be perfect, but it will get more right than wrong

How to implement a stop-loss system (an example)

Ric and Geoff look to float the Fill ya Boots! web site at an initial price of 50p per share.  At the outset, you decide to set a stop-loss on the price at 15%, which means you should sell the shares if they ever reach 42.5p (15% of 50p = 7.5p, therefore 50p – 7.5p = 42.5p). 

As the price rises, so you raise the stop loss with it, protecting your profits and limiting your losses.  When the share reaches 100p for instance, you would set a stop-loss at 85p (15% of 100p = 15p, therefore 100p – 15p = 85p), so that if the price falls, you have still gained overall.

The crucial point to remember when using this system, is that although the stop-loss is able to rise, it will never fall below its current limit – that is the time you will sell the share.

If the following week Fill ya Boots! started to fall, and dropped to 80p one day, you would still of sold the share at 85p, and overall have made a profit of 35p per share.

That’s it, it really is that simple to work out, and implement.

Conclusion

It should not be underestimated how important the use of a stop-loss system is, whether you are doing this as a hobby yourself, if you are a member of a share club or a long time professional investor.  There is nothing complicated about the system, it simply takes out the ‘emotional’ side of selling shares, some of which you may have held for long periods of time.

It is workable most of the time, but you must also watch prices yourself periodically for it to be truly effective. 

Good Luck !

Article researched and written for Fill ya Boots! 

by Les Fearn 27/01/00