A Bourse Diary

Thoughts on stocks, speculation and ... life

Friday, November 25, 2005

On Stop-Loss

Particularly beginners are always told to "protect" their trades by "persistently" setting a stop loss orders as if it were a nearly a "miracle weapon" to minimize losses and hence boost overall performance. The second "hint" that very often follows then, is portfolio risk protecting (or hedging) through put options.

I find that one should not protect the risk of stocks. At least not in this way. By the hedging the investor cuts finally his performance. The risk protection (or balance) is to be taken rather by diversification of the entire portfolio on the different investment classes (bonds, shares, real estate etc.). In the class of the shares itself, one should not "protect" - the risk of the investment is "paid" by (possible) higher yield here. The volatility, which can be very substantial, is part of the risk and part of the price. If you consider the risk of holding stocks too high, then buy less stocks and distribute your money more into the other investment classes. To protect the stocks portfolio is quasi to make from shares bonds. From fiscal point of view some hedging strategies can be of course derived (at least in Europe), but this is not the theme. If you come to invest on the stock market, you do have to be able to live with the volatility of stocks, otherwise it's just the wrong place for you...

Risk balancing and protecting strategies conduct for instance banks or funds, but this is not investment in the actual sense, still less speculation. It's other people's money that is hedged e.g. in the structured products (warranty, bonus certificates etc.). The banks in most cases do not speculate, the banks earn at the fees etc. and not at the market, therefore they hedge the market movements.



1 Comments:

At 12:00 AM, Blogger Loi Tran said...

Great blog on investing. There has been a lot of different opinions on stop loss. I've heard some people saying that they should keep their stop-loss at 8% and others saying saying to keep the stop loss at 20%. I, like many others do not believe in stop loss. I am that sure of my investments, and when the price goes down, it is at selling at a bargain for me and I should buy more. Setting arbitrary stop loss on a volatile investment will surely make the investor lose the amount the stop loss is set at.

 

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