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Why Not to Use Stop Loss Orders

admin on 05 13, 2010

Video Below

Everyone has heard about the collapse in the market last Thursday.  Magically, the EU decides to create $800 Billion out of thin air to back the countries that are in trouble.  Spain recently cut their public workers’ compensation by 5%.  Last week in our webinar on protecting your portfolio, we talked about how to hedge your entire portfolio.  We wanted to do a quick video on why using Stop Loss orders will NOT protect your stocks or your portfolio.  Stops can be stop limit or stop market.  They are usually used for downside protection, but can also be used when you short the market.  Basically they are a way to enter and order at a specified price where you would want to exit if the stock falls below that price. A stop limit is when the price of the stock falls below your trigger price and then an order is entered to sell at a limit price.  A stop market is after the stock falls below the price you sell at market price.  When you are in fast market conditions, like last Thursday, there is no guarantee on your price.  The flury of sell orders and triggers and lack of buyers caused the waterfall effect.  As we fell through more support areas, more stop orders were triggered.  This forced many investors to take huge losses on stocks that they have held for years.

Once stop orders pushed through 10,700 they quickly got to 10,500 and when no one was ready to buy at that level the computers took over.   Algorithmic trading by the big hedge funds have multiple computer models.  As momentum picks up some models take over.  The more momentum the more the computers push.  The end result was a reversal in a matter of minutes to get back over 600 points on the DJIA.

Watch the video below for more information:

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