How Investors Should Use Stop-Losses

Stop-losses are not only tools for traders to protect their capital. Investors should also design their own stop-losses to help them decide when to exit positions.

- Simon Brown

I in my column A simple rule for trading: It’s all about controlling your losses, which was published in the 29 June edition, I wrote about using a stop-loss to protect a trading portfolio and generating profits by removing all large losers, which generated a flurry of reader comments. So, this week I’ll expand on the concept.

The first question is: are you trading or investing? Several investors seemed very alarmed by my comments and I agree with them as investing is very different from trading. You would use stop-losses differently depending on which process you are following.

Typically, a trader mostly (if not exclusively) uses price to generate entries, holds for a period shorter than three years and often uses derivatives. An investor mostly uses fundamentals to determine which stocks to buy using price only for value, has a holding period longer than three years and never uses derivatives for the position.

My column from a few weeks ago was aimed squarely at traders, not investors.