Why Stop Losses Don’t Make Sense

Here’s the situation, you bought a stock, and it went down. Everyday, it goes down. And when finally, you saw a little bit of hope, after a few days of red, the market turned green. But your stock still went down. Now, there are a couple of things going through your head as an investor in this kind of situation.

Shall you add more or sell?

What many sane beginner investors (or traders) would do was to cut loss. Take the losses and moved on. Others, will have a stop loss, an automatic sell trigger if your stock hit a designated price. We don’t have this functionality in most brokers in the Philippines, but you get the point. You have a certain price in which when hit, you sell.

This stop-loss is a part of a strategy in trading circles that goes into the “risk management” territory. It is managing risk… Not risking too much into the stock to let it go down more than, let’s say 5%, or whatever the trader or investor aims to be logical.

But here is where I don’t get the point of stop losses or cutting losses. Investing rule # 1 is not losing money. Selling at a loss will invalidate the most important rule of investing. If that’s the case, are you saying that people who followed TRC to buy CHP at P13 a share should not cut loss until the painful drop of P1.75 per share?

No. That’s a different situation that I will tackle later in this post. What I want to explain first is the irrationality of cut losses and stop loss using investing, but in a different field.

Investing Like Real Estate

So lets say you bought a house as an investment. Its a very good looking house, nice location, nice neighborhood, nice everything. You bought it at a good price too. Let’s say you bought it at P2 million while the market value was P2.5 million. Good job for finding a bargain by the way. Now, this house provides you with nice rent. Around P10,000 monthly, with good tenant that its basically a passive investment for you, that you don’t have to manage.

The problem arise when recession hits. Interest rates went up and people aren’t buying anymore houses. Either, they can’t or they won’t. But the idea is clear, your P2 million investment is (as your realtor told you) now priced at the market at P1.5 million.

You just lost -P500,000 on you investment. Are you going to sell? Are you going to cut your losses? Of course not! That’s a very irrational way to invest. You will sell when it becomes cheaper? I’ll be sure to contact you when you panic like that, because now, I could earn P1 million on your investment if you sell to me. Just by buying, I can make profit going in.

So can you see why stop loss are practically, does not make sense to me? People are selling their stocks, when the stocks got cheaper. They are supposed to be buying when stocks goes down, not selling. When a shirt in the department store that sold for P1000 retail and goes into holiday discount into P500, you’re not gonna buy?

Selling for the Wrong Reasons Means Buying for the Wrong Reasons

Now, let me address the situation of TRC recommending CHP at 13 and stuck until 1.75 because they did not cut loss.

For those who don’t know, TRC is a membership club by the author Bo Sanchez wherein they will give you a list of stocks to buy, for a monthly fee. They recommended to buy CHP at 13 and now the stock trades at 1.75. To put that into perspective, if you followed their advice and bought CHP, your initial investment of 1,000,000, will now, today be worth around P134,615. You lost almost P900,000 following their advice.

To be fair, its not only Truly Rich Club who gave out this losing recommendation. Stock brokers like COL Financial also gave a buy recommendation on CHP at the same price. But at least, COL Financial isn’t asking for monthly fee for their stock picks.

In investing, selling is the hardest part. So much so, that I avoid selling. I don’t want to sell. Because its really hard to sell right. Which means, in the process of buying and selling, I only have to make a decision once. I only focus all my efforts into buying. If I focus all my energy into buying the right company and not selling, life is easier.

The problem with TRC recommending a buy on CHP at around 13, is that, the first decision is wrong:

Five reasons why buying is wrong:

1. They recommended to buy an IPO stock to unsuspecting members. Its a very bad deal if you’re buying at IPO.
2. You don’t know the track record of CHP.
3. You don’t know the “real” track record of TRC. Real I mean, audited. How have their recommendations performed in the past in good and bad economic climates?
4. Conflict of Interest – the analyst and even the owner of TRC themselves, do you think they have the majority of their own net worth invested in CHP? Are they risking their necks together with you? Probably not, and there lies a problem.
5. Its your fault to outsource the most important part of investing – thinking.

Now if all of these things go together, what you have is an ugly investment. As soon as you realize this, cutting your losses may be a good choice. But if you do the buying right, you don’t have to cut loss even if the stock went down.

Buy right then hold on. Or on the special occasions, buy more… Stop loss and selling should be far from your mind.

P.S. People might suspect that I’m throwing trash at TRC, far from it. What I want people to realize is that, its your money, so you should never let other people handle it or tell you where to put it. If its life savings, all the more reason to be prudent. If you don’t have time to learn or monitor your stocks, why not buy an index fund?