The Rule to Save Your Retirement

You can’t teach an old dog new tricks, which is why, despite all their financial logic, stuck-in-the-mud, long-term, set-and-forget investors refuse to consider using stop losses.

Let’s face it, computers are just too hard, so is stock market software, and who wants to be seen as a trader, a manic obsessive, with sunken eyes and a pale complexion, McDonald’s mayonnaise dripped down the front of their T-shirt, stuck in a darkened room trading online and never seeing the light of day.

God forbid. And anyway, if your grandad had used stop losses, he’d have sold those BHP shares back in 1886.

Everyone who doesn’t want to engage brain has a great reason, in the stock market, in hindsight, why it’ll be alright in the end if you just do nothing.

Well, if that’s as far as you are prepared to go to protect your retirement, then fair enough. You’re a hopeless case and you will just have to rely on the market always going up. You never know, you might be right.

But you’re ignoring the fact that if you’d used even the laziest of stop losses, you might have also sold those ABC Learning, and Babcock & Brown, and you might not have lost 54.5% in the GFC and saved yourself thirteen years getting back to where you were in 2007. And you also, by the way, ignored one of the greatest opportunities to buy at the bottom and exploit the years of accelerated gains that were on offer to those who bought anytime after March 2009.

I think the problem with stop losses is the label. Stop losses require you to “admit to failure”. No wonder they don’t catch on. Perhaps if we called them “Capital Preservation Points”. CPPs. Something impersonal. Maybe then they’d be popular.

Meanwhile, here are some things you may not realise about stop losses. Sorry, Capital Preservation Points:

• No, you don’t have to become a trader. You can still be a long-term investor and use stop losses; you just use longer-term parameters on exactly the same principles.
• No, there is no Holy Grail method for calculating stop losses; there are just a lot of different ways. Best you keep it simple. In our experience, the rather silly truth about the fancy ways of calculating stop losses, trailing stop losses and stop profits is that they take many different routes to come to just about the same answer. Around 5% below the share price, 8% for a more volatile stock, and 3% for more boring stocks like Telstra and the banks.
• If you really don’t want to be active, use weekly stop losses. They smooth out a lot of noise. They’re a bit wider than daily stop losses, generally double. They tend to come out at around 10% below the share price for a normal stock, 6% for stable stocks like Telstra, and 15–20% for more volatile stocks.
• No, there is no magic in a stop loss. Ninety-nine percent of the value of using a stop loss, especially as a lazy investor, is that you are provoked into decision and action. They are not saying “you must sell”, they are saying “Wake up, you’re losing money”.
• No, your broker won’t do it for you because if they say they can, they won’t be able to go to the toilet in case your stock goes through the stop loss and you sue them for missing it. Some online broker software can handle stop losses (contingent orders), but without that you’ll have to do it yourself.
• No, you don’t have to watch the stock market all day, not as an investor. Check your prices and adjust your stop losses once a week if you like, once a month if you insist.
• No, stop losses aren’t just for bear markets; if anything they are more important in a bull market because they help you take profits, something you set-and-forgetters are particularly useless at. To use them as a “stop profit”, you simply set them below the highest price the stock has hit since you bought it and adjust the stop losses up as the shares hit new highs. These are called trailing stop losses.
• No, you don’t have to sell when a stock hits a stop loss. It’s not an instruction, it’s an alarm. It is alerting you to the fact that the share price has gone down, that’s all. It’s up to you what you do about it.
• If a stop taps you on the shoulder a few times (three weeks on the trot), go and have a look at what’s happening.
• Or just be disciplined. When a stop loss is hit, just sell. Nine out of ten falling stocks keep falling.
• If it’s wrong, you can always buy it back.
• No, you’re not supposed to lower a stop loss except to adjust for dividends and adjustments to share price histories after things like rights issues. Otherwise, they are on a ratchet.
• If a lot of stop losses go off in succession on your weekly spreadsheet update, they are telling you something: that the market is going down. You might want to react to that.

Ultimately, stop losses, sorry, Capital Preservation Points, do little more than that: a smoke alarm. They say, “Something’s burning!”. Your retirement maybe.