Many people will tell you that one of the best ways to limit your risk is to employ a stop-loss on your investments. It's a common practice across the investing landscape and one I don't use -- and won't use. Ever!
Over the last few years, readers have consistently asked me why I don't use stop-losses in my deep-in-the-money (DITM) call suggested trades. They argue that the use of a stop-loss order can protect against sharp losses if a stock plunges.
A stop-loss, essentially, is an automatic trigger to sell shares when the price falls to a predetermined level. It helps people place a limit on how much they are willing to lose and when it's time to say enough is enough.
So why don't I like them? Because each trade is different and market conditions change from day to day. And while I have a system, I think applying a blanket methodology to realizing losses is insane.
I have developed a system that dictates what I do when a stock moves against me. That system calls for averaging down, or buying more options contracts as the price of the pick falls to certain levels.
I actively monitor those levels and set and reset them on a regular basis. It's not a set-it-and-forget it type of thing. I play by those rules.
If a pick goes south, that doesn't mean I need to bail at a specific time or value. I did my homework up front. I picked a solid company that is being unfairly punished by the market, and I was careful in my selection process.
Yes, picks will go against me. That is expected from time to time. It's how you manage those instances that matter most.
Employing a stop-loss contradicts my methodology of averaging down. I ride down with a stock to the bottom, adding to my position along the way to lower my average entry price, and capture a gain on a small bounce. A situation that may trigger a stop-loss might call for me to double up using my system. If I sold, I would realize a loss instead of repositioning myself for a gain -- likely a much bigger gain.
The absence of stop-losses doesn't mean I am open to unnecessary risk. It just means I watch my trades and look to multiple variables before pulling out of a trade. I don't like the idea of having an automatic sell order in -- there are too many variables that could make me sell when I shouldn't.
If something occurs in the market or within a company I have picked, and I feel it warrants re-evaluating my investment, I will let you know. That hasn't happened for me yet, but because I am watching the market all the time and see everything that goes on, I know a lot can change.
Always remember: Life is a journey, enjoy the ride!
At the time of publication, Dykstra had no positions in the stocks mentioned.
Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."