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Sunday, 20 March 2016

Cut loss is not Stop loss



Before we start, this post is a direct answer to Sillyinvestor's Stop loss vs Cut loss post. 

It's supposed to be a comment to his question, but what he asked is the crux why so many retail traders and investors have problems making money, hence this post to do it justice.



1.  Stop orders

It's just a system platform order type to "automate" a buy or sell decision when the market moves to our predetermined entry or exit prices.

It's just a tool. Nothing more; nothing less.

Most retail traders and investors think a stop order is only an exit order - be it a stop loss (limit loss) or profit stop (protect profit).

A stop order can be an entry order too.

Let's assume STI is a stock. When STI is around 2600, you have no clue whether it will break 2500 or 2700 first.

A bull can enter a stop order to buy when STI breaks 2710; while a bear can place a stop order to sell at 2490 when the 2500 support gives way.

This way, they don't have to stare at their screens all day; especially when they have a full time job. 

No, not all full time traders are glued to their screens - those are intraday traders.



2.  Cut loss

This is an exit decision by a trader or investor to get out of a money losing position. 

Let's say the bid price is $1.00 and offer price is $1.01

This exit decision can result it the following execution order types:

a) A market order to sell on the bid at $1.00 (Get out quick!)

b) A limit order to sell at $1.01 (Trying to be cute to save on the spread)

c) A stop order to sell at $0.95 (That's your pain threshold but you don't sell immediately as you still harbour hopes for a reversal. It's a bit like the commercial where the gambler dad asks his little daughter for her piggy bank for one last try...)



3) When the reasons you bought are no longer valid

Sillyinvestor interpretation is:

"Cut loss, when fundamental has changed or your underlying assumptions made in the company has changed/ no longer valid."

You are only half right.

When fundamentals change, why does it have to be a "cut loss"?

It can be taking some money off the table (scaling out), or selling out completely at a profit too!

And sometimes, you don't need to wait till fundamentals to change.

Most readers have not understood my poke to failed traders masquerading as "value investors" - Here's a question to Value Investors.

Many know how to parrot buy when there's blood on the streets; how many practice the reverse as in selling into the euphoria?



4)  Protect your profits

All these discussions on cut loss versus stop loss is missing the point.

The main reason why most retail and amateur investors/traders don't make money is we don't protect our profits!

Think about it for a minute.

If we knew how to protect our profits, is cutting loss a problem anymore?




P.S.  Newer readers who have no clue what are the 3 Ms may want to go here:






29 comments:

  1. SMOL,

    When fundamental changes for the better, it is call profit taking but usually when results surprise on the upside, u roll with it and dun sell.

    We expect an company to deliver x% growth and expect Y returns, so if company surprise on the upside with X2 growth, u can be happy the returns should be higher.

    Also, the most fundemental question of stop loss vs accumulation/ AV. Down is not answered. I know there is no easy answer.

    It is not a question about selling to take profits, it's about selling to reduce loss or preserve capital.

    Most importantly, the inherent conflict of 10% loss or whatever threshold to protect loss, and the fact that my analysis is wrong if price go down 10%. If I sell at 10% loss and pick it up at 20 or higher discount, of course you trumpet, but it could well be 11% and it rebounded.

    You sold at the worst possible time.

    SCI I would have done better with 10% cut loss. But if my short records is any guide, it would not have worked for YzJ and (accumulate more at 20% discount and sold all for 35% profits excluding dividends)

    But of course, if I apply 10% rule for all counters and would have missed more dudes that I missed a Gem.

    Gem - would have missed STE, YZJ, MIT
    Dudes - would have escaped Lee metals, LMIR CMPH, SCI, FST,

    Would not have matter
    a-reit, Venture

    Even if LeE metals have already break even at current prices including dividends and the net records would be still better off...

    Getting something but still :.

    ReplyDelete
    Replies
    1. "When fundamental changes for the better, it is call profit taking but usually when results surprise on the upside, u roll with it and dun sell."

      by the time, you realise fundamentals changed, it is no longer news.
      just that, there are more people more stubborn than you.


      by the way, try learning to use only stop loss.
      don't keep wanting to take profit.

      just try it.

      Delete
    2. Sillyinvestor,

      That's why we say newbies need to go through 1 or 2 full bull/bear cycle to really know themselves and know what strategies and vehicles work for them.

      That's what an investing diary or trading journal is for.

      With time (especially when you have your first 50% loss at portfolio level), you'll figure out the optimum money management strategies and tactics that's customised for you and you alone ;)


      Give you a free poke:

      What do you do when you realise you were "wrong" or fundamentals have changed?

      And if you had ACTED, how will "You sold at the worst possible time" ever occur?

      Wink.

      Delete
  2. "A stop order can be an entry order too."

    my first thought is huh?
    then I realize that not everyone trades.

    "It's a bit like the commercial where the gambler dad asks his little daughter for her piggy bank for one last try..."

    yes, my discipline lacking at times.

    "3) When the reasons you bought are no longer valid"

    yes agree with SMOL.

    3 & 4

    I am a value investor too. LOL
    I only use stop loss not cut loss.
    not hao lian because I lost money too.

    so why "only stop loss" and no cut loss leh?
    in fact, why no take profit?

    ReplyDelete
    Replies
    1. SMK,

      A bit funny right?

      Retail investors who are constantly "unlucky" with their entries - most positions under water - would have capitulated and quit DIY investing.

      Those more logical ones would have either switched to passive indexing or outsourced their investing to professional active management.

      That means those retail investors who are sticking with DIY investing are those at one time or another, sitting with majority winners in their portfolios. Woo hoo!

      Why let profitable positions end up to be money losing ones???

      And spend time musing whether should I cut or not cut???

      Fixing the barn door after the horses have bolted?


      "Quitting when we are ahead is not the same as quitting".

      (I don't know who said it; but I'll steal with pride again)

      Delete
    2. "That means those retail investors who are sticking with DIY investing are those at one time or another, sitting with majority winners in their portfolios. Woo hoo!"

      I don't know about that. LOL some have teared up their old tickets and bought new ones.

      I think my previous comment is not precise.

      I don't take profit. I only stop loss.

      Delete
    3. SMK,

      That would make you a stamp collector ;)


      There's some adjectives for people who continues to DIY invest yet lose money year after year - compulsive, addicted, habitual, etc...

      Delete
    4. "That would make you a stamp collector ;)"

      don't know what that means.

      Delete
    5. SMK,

      LOL!

      How about accumulating scout badges?

      You never take profit, that means you never sell.

      Never sell means "collector" lor!

      Delete
    6. Never take profit doesn't mean I don't sell. In fact, I probably sell more than the average investor.

      I stop loss only means I mostly get stopped out. But doesn't mean I don't get profit.

      Just that I don't have a target profit. So I never actively take profit. I am not a scalper. I only frequently find my stop loss either at or slightly above where some may take profit.

      Different stocks and different markets also have different ways to read. The thinking of a taiwanese is very different from a singaporean too.

      Delete
    7. SMK,

      Just verifying ;)

      I never take what people says at face value. Must flesh out more details to get the context and perspective :)


      Welcome to Singapore!

      I have worked for Taiwanese bosses before. And when travelling to Sweden alone, I've always enjoyed the hospitality of my Taiwanese colleagues who included me as "one of their own" during meal times.

      Taiwanese, you guys are a class act!

      Got very strong 人情味!

      Delete
  3. Hi SMOL,

    I've not cut loss or stop loss for investments before but for trades I've done both. I got stopped out too early because it was too close and I felt silly so after that I just go with manual cut loss although I think at the start stop loss works for newbie Traders since it takes the emotions out from me. For cut loss, I did that a few times and even now months later, some of them have not recovered in prices and even if they had, it would have turned from a trade to an investment and that's a no no since I'll be out of capital. Now I use a smaller trade size and focus on getting it right rather than making it big and use a tighter time frame...works better this way for me.

    ReplyDelete
    Replies
    1. Joyce,

      Stop loss is a subset of cut loss which is a subset of money management.

      And as you have rightfully pointed out, there's more to money management than simply cut loss ;)

      We have to know the full context and perspective of what we are talking about:

      1) Is the position a trade or investment? (Time frame)

      2) Is leverage involved?

      3) How big is the position relative to the total portfolio?


      For eg, if I am only risking a miserly $1K on a single position, I can also talk big I never need to cut loss or what not!

      But if its a core position, a simple 20% loss can be the equivalent of condo or multiples in BMWs, well, we better not be too sanguine and blindly quote Peter Lynch when we don't have a single 10 bagger to our name ;)

      Delete
  4. Hi SMOL,

    A side-track question if you know which is a good trading platform that has easy-to-use and different types of stop orders?

    Stop loss or cut loss? They are affected by 1) deepness of our pocket (or stomach) and 2) the strategy we deploy which is in turn affected by our knowledge of the market and tools we possess.

    Whether we deploy stop loss or cut loss, both are good ways to limit losses. I regretted not stopping losses in a down market and buying towards the bottom. I have cut losses to those investments that remained as salted fishes, albeit sometimes too late (I guess same mindset as the commercial).

    ReplyDelete
    Replies
    1. Rainbow lady,

      For equities, most retail platforms are quite "basic".

      I only know for equities trading, there is an advance platform for retail active traders that have quite a lot of advanced order types - Phillip's Protrader.

      But that's quite expensive if you are not active.

      Explore the CFDs platforms instead. They are free.

      In general, those with leverage vehicles have "better" platforms and order types for money management - the brokers have vested interest to help you stay alive longer so they can milk more commissions ;)


      Other more advanced platforms are more for institutional traders and non-equities vehicles. Go to Phillips futures website and you know what I mean ;)

      Delete
    2. Hi SMOL,
      Thank you for the info. I intend to open a Philips acct but has been too busy lately to check out the investment literacy tests (which need to be passed first to open acct).

      Delete
  5. Hi SMOL,

    Good post. I learnt a thing or two here too :)

    I think poems retail acct (free one) is getting better. There are a few advanced order types too which I had been using for a while. Now there's good to date, stop limit, limit if touched..okay lah, not as advanced as the pro version, but it's gd enough for me. Note that this isn't CFD.

    ReplyDelete
    Replies
    1. LP,

      Thanks!

      Yes, POEMS 2.0 is a very good upgrade - finally got stop orders for retail ;)

      That's a start!


      Cannot complain; but when compared to the CFD, forex, and futures platforms, still got room to improve...

      Especially when one has a corporate job full time, I would think some of the advanced order types would be useful to "automate" some of our entries and exits:

      1) If done

      2) Contingency

      3) OCO (One cancels other)


      Iceberg and Fill-or-kill order types most retail investors don't need since they are more for the bigger and super active traders ;)


      P.S. Imagine the irony when I use word plays to help untangle others from being trapped by the narrow definition of words; here I am being anal to show:

      1) Stop loss is just an order type.

      2) Cut loss is a decision we make.


      So when one says he never uses stop loss, only cut loss - it's like saying one never drinks from a straw.

      OK lor... We can drink from a cup, straight from the bottle or tap, with our hands, etc...

      Big deal.

      LOL!

      Delete
  6. Also must remember a "Stop Loss" price is not a guarantee.
    So i very seldom use.
    Especially when a sudden market crash, just in case.

    ReplyDelete
    Replies
    1. temperament,

      We all fear the big gap down and gap up situations.

      Not just on during market openings; like in 87's Black Monday and the recent mini flash crashes in forex.

      Stop loss orders can be quite dangerous for illiquid counters too.

      Delete
  7. i may use it selling into a bull market.

    ReplyDelete
    Replies
    1. Ah yes!

      Qian beis all know how to "protect" profits ;)

      If not, after 30 years in the market, we would be still aiming to break-even...

      And that's not what we had in mind when we started our journeys as investors or traders in the first place ;)

      Delete
  8. i think stop limit order is a better choice selling into a bull market You may even get a slightly better selling price.

    ReplyDelete
    Replies
    1. temperament,

      LOL!

      I think you just lost those retail investors who never ever used stop orders before.


      I think this is a good example where retail investors who are not too proud of themselves can learn quite a bit from traders ;)

      It's a bit like saying graduates can learn a lot by working in sales or reading about selling and marketing; even if you don't major in them.

      Selling an idea or business proposal is selling too! Even selling yourself as a marriage partner potential requires selling!!!

      But then, they will be some who will look down on salespersons and traders.

      I would think we are still in ancient China where traders are ranked right at the bottom below farmers???

      LOL!

      Delete
  9. i think a person's temperament determine what kind of orders.
    Therefore he is mainly a short term trader or longer term trader.
    Me- my preference is i use limit order buy or sell. Once in a while i will use market order.
    i even use GTC order now.

    ReplyDelete
    Replies
    1. temperament,

      That's the Mind part - knowing who we are and can think for ourselves; not blindly following others.

      Mental cut loss can be used if one is super disciplined.

      And similarly, if one is quite "emotional" and has difficulty sticking to one's original risk management plans, stop loss orders can be a tool to take out the emotions and automate our decisions - even if one is a long term "investor".

      There are buy and hold investors who believes in getting "insurance" ;)

      Delete
  10. Hi SMOL

    very deep. all we need to do is to buy....sell....some people buy and forget....easier? Only if they are really that forgetful. Please don't short (sell), and forget to buy.

    I don't have an answer. However, what I do know is, sticking to your original plan is always the most difficult. And, not every investors and traders have an original plan to begin with.

    What do we do, when our original plan don't tally with the Mr. market? I have no idea. Too flexible, you will be accused of shifting goal post without principals. Too rigid, you will be accused of not able to follow the time. Just nice? Where is the fine line? Don't care about what other people say? You will be accused of being self centred. Care too much? You will be accused of trying to please too hard. Who we need to prove to? Just get that profit and enjoy life. Sounds easy, but...how? how?

    ReplyDelete
    Replies
    1. Frugal Daddy,

      Deep? No. Irreverent? Yes!

      My headline is a poke to those who can't see a discussion between cut loss and stop loss is really about:

      Discretionary versus mechanical entries/exits.


      If one has "difficulty" sticking with one's own plans or pulling the trigger, then more advanced mechanical order types can be a solution.

      "Difficulty" here need not be about the investor's Mind part, it can also be his work situation.

      1) Desk bound versus lots of travelling.

      2) Condemned very free versus lots of meetings.

      3) Have access to wifi versus no access at work.

      4) And so on.



      If investing were easy, 2/3 of those who used CPF to "invest" won't be investing to break-even...


      It's best to invest through our own volition.

      And not because some bleeding heart or snake oil "encouraged" us.

      Being warm blooded and cold blooded in investing makes a lot of difference!


      Warm and Cold blooded

      Delete

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