i think the stops debate will never be settled. in hindsight, there will always be instances where stops would have been prudent, and always instances where they would have resulted in an opportunity cost.
still, i have an opinion on them, especially from the value investor's perspective: one thing that can be said with certainty is that stops result in higher trading costs. this is of particular concern to the value investor trading in relatively illiquid stocks. the trading cost is not just the $5 or $10 or $30 commission; the real damage is in the spreads, which are extreme on illiquid stocks. therefore frequent trading in and out of value names is, imo, a losing strategy.
btw, the situation is much, much worse when one is trading in foreign small caps on foreign exchanges as i do. it would be easy to take a 10-15% haircut on a round trip in these positions. the only way i can justify such investments in the first place is if they are multiyear holdings. this reduces annual trading costs considerably.
on the one hand, (mental) stops saved my portfolio by getting me out of bubble stocks with acceptable profits before the collapse. on the other hand, as i invest in value stocks now, i do not rely on stops and am glad for it.
imo, a more prudent strategy than stops is maintaining good diversification and keeping positions to reasonable sizes. in my own case, a "massive" position amounts to 2% of portfolio value, and a more typical position is in the 0.5% to 1.5% range. back in the bubble days, i routinely had positions equal to 200-500% of portfolio value (through options and leveraging), so entry and exit prices were more important.
now my only involvement with public tech stocks is on the short end. i also avoid stops on these positions, but they are small again (0.5% typical; 1% max), and i am quite confident that they will be profitable even if they take temporary 50% paper losses due to some shortsighted mutual fund manager playing with OPM. but again, my working rule is to keep the positions small.
i actually find a willingness to suffer short term paper losses on my tech shorts to be very important to long-term profits on these positions for me, because a lot of money shorts these names and they get scared out easily, resulting in frequent short squeezes. these occur with frightening regularity, but ultimately the weight of overvaluation comes back to these names and they go where i want them to (down); trying to scamper in and out with stops would just take me out of this game with losses. |
