by Mj Ferruzza

Created on: January 19, 2009   Last Updated: September 25, 2009

I have played the stock market for years. I used to follow the old school advice of buy and hold. This was a practice I learned from my father and his stock broker. When my father passed away, he was no wealthier than any of the other men in our neighborhood who used the same local broker. The broker who would continue on selling and investing for our family the same way for years. But I was not satisfied with this system and our rate of return, especially during down economic times. I became a more savvy investor using a technique I learned from a well to do investor. This system has served me well as an investor and day trader.

I play the options market. It is a bit risky, but I have learned to hedge my investing prognostications with a stop loss technique that most investors can and should learn. They should definitely utilize this system during a topsy turvy market in either bear or Bull times. It may be an added expense to the investor who can spare a loss or two (or more) on investments. But to the average traders the stop loss system is a keen way of protecting purchases of shares while minimizing risk.

The stop loss system works like this: You contact your broker or just add to your own on line stock or option purchase a limit on just how far it can dip before it automatically sells off. You can set the limit at 10% the original purchase and then only assume a 10% loss of your investment if the market turns against you. This is a great way to protect yourself, especially if you are heavy into one stock or option. This is a very protective strategy, especially if you take you eyes off the market for any extended period of time.

The cost of placing a stop-loss order can be an added expense to your shares or contracts, but well worth the headaches a larger loss would cause to you and your portfolio. The downside to all of this is that those that set a stop-loss around 5-7% may have it activated by a small, if not short term fluctuation in the market. 10% maybe too low a mark, if the stock price stalls and stays level. Also, once your stop-loss is activated, the order to sell is set at as a market order. You may not get the price you had set, you might lose a bit more depending on how fast the stock is dropping and how quick your order can be filled on the floor of the market.

Since a stop-loss is a simple tool to protect your purchases, it eliminates some guesswork and takes a bit of the emotional human element out of a purchase. By knowing that you are prepared to lose only a set amount of the purchase price, you don't harangue about a total loss of investment and can sleep a bit easier at night. You can take that vacation without looking for a Business section of the paper or have your broker as the #1 button on the speed dial of your cell phone.

Keep in mind, there are a few stocks that don't allow for a stop-loss order. Many bulletin board, over the counter, penny stocks can not be protected with this system. It is best to take this into account when you want to trade a stock from a tip or with a company which has share trading you aren't familiar.

I see stop-loss as a stop gap system for the active trader who is beyond the buy and hold formula, but not as intense as a locked at their computer day trader. But if you are a trader and you do want to limit your losses, this is a simple but effective tool for you.

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