Whatever platform you use for stock brokerage, you’ve maybe come across the term “stop-loss”. What this means is that you set an order to your broker to sell a stock if it e.g. drops below 10% of your purchase price. Thus, your loss will only be 10%. In this post I’ll explain why this makes absolutely no sense to the intelligent investor.
Peak Irrationality
Imagine you bought a house for 100,000. You weighed the pros and cons of the area, and estimate that due to the growing popularity of the area it will be worth more in the future. You also intend to live there for the foreseeable future. Then someone comes and says they wan’t to buy the house for 98,000. Of course you decline the offer. Then he arrives a week later and says he wants to buy the house for 95,000. You decline. A week after that he offers to buy for 80,000. For some irrational reason, you sell it to him.
The described scenario makes absolutely no sense. Essentially, this is what you are doing by having a stop-loss order. If you use it, it shows you don’t actually know what you own. We all make mistakes, but in investing, you are your worst enemy. Don’t let Mr. Market bully you into doing something stupid. Because of our own irrationality, investing is simple but not easy. Sometimes it is hard to ignore the barrage of opinions from all the talking heads. What you need to do is unplug yourself from all the noise, only focus on what matters and facts. These are the figures, statistics and reports that the company itself gives out. The information is public knowledge, but we interpret the information differently.
Stop-Loss Takeaways
- Stick within your circle of competence, and give your attention only to things you know.
- Ignore the talking heads on the news, most of it is just nonsense. Their job is to get viewers. The more dramatic the news, the more attention it grabs.
- When the information barrage gets too overwhelming, remember that you are your worst enemy in investing. Always refer back to the facts.
- You’re in this for the long-run. In the short-term, the market is a voting machine, in the long-term its a weighing machine.
For those who want to learn more from one of my favorite investors, here’s an interview with Mohnish Pabrai.
What do you think about stop-loss orders? Leave a comment, and I’ll be sure to follow up with you!
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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