Investors typically employ stop orders, which are used to buy or sell securities at a specific price, for short-term trading. But they can help manage a diversified investment portfolio.
The first issue is where to set a stop price. Many people place a stop order 8% below the purchase price, though that type of move is common for some stocks.
The following chart compares the 2009 performances of
. Clorox doesn't move a lot, so using an 8% limit make sense. Citigroup has had ups and downs exceeding 10% on 50 of 83 trading days from the end of the year through May 1. Plenty of other shares behaved the same way in the bear market, which is problematic because almost everything declined dramatically during this period. As a result, your brokerage commissions would have gone through the roof.
Another potential issue with getting "stopped out" is that your stock, which presumably you liked when you bought it, turns around and rises quickly. An example is
. From an intermediate high of $41.81 on Feb. 6, Deere fell 40% in less than a month as investors panicked. Deere climbed above that level less than two months later. Anyone nimble enough to have bought it in the mid-$20s after getting stopped out in the high $30s would have had a fantastic trade. An argument could easily be made for having held on as the stock has more than recovered.
The last issue to address is why you bought the stock in the first place. It would make sense to think of a stock as a proxy for a sector or maybe a country or theme. Sticking with Deere as an example, an investor who bought the company shouldn't have presumed the recession would be L-shaped. Anyone buying Deere was looking for a way to capture an economic turnaround.
In that context, it would make sense for Deere to have badly lagged the
Industrial Sector SPDR
on the way down in February and then dramatically outperform in the rally that started in early March. Getting stopped out to avoid an uncomfortable couple of weeks would seem to be counterproductive.
Stop orders have a certain utility, but like any technique or tool, they have drawbacks.
At the time of publication, Nusbaum had no positions in the securities mentioned.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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