Stop-Loss Strategies: When to Use Them and When to Avoid Them
Explore types of stop-loss orders including trailing stops, percentage-based stops, and volatility stops. Learn when stop losses help and when they hurt long-term investors.
Types of stop-loss orders
- Fixed percentage stop: sell if the stock drops a set percentage from purchase price
- Trailing stop: automatically adjusts upward as the stock rises, locking in gains
- Volatility-based stop: sets the stop distance based on the stock's typical price swings (e.g., 2x ATR)
- Mental stop: a predefined exit point tracked manually without placing an order
When stop losses help
Stop losses enforce sell discipline and limit catastrophic loss on any single position. They are most useful for momentum or technical traders, concentrated positions, and situations where you cannot monitor the market regularly. Trailing stops can be effective at capturing gains in strong uptrends.
When stop losses can hurt
For long-term value investors, stop losses risk selling a fundamentally sound stock during temporary volatility. A stock that drops 15% on short-term noise may be an even better buy, not a sell signal. Tight stops in volatile markets can result in frequent whipsaws -- getting stopped out only to watch the stock recover.
In backtesting, many stop-loss strategies underperform buy-and-hold for long-term investors. The stocks that trigger stops often recover, and the transaction costs and tax drag from frequent selling compound over time.
Monitor Your Holdings
Track intrinsic value estimates and price movements to inform sell decisions.
FAQs
What is a good stop-loss percentage?▼
There is no universal answer. It depends on the stock's volatility, your time horizon, and strategy. Common ranges are 7-15% for swing traders and 20-25% for longer-term holders, but many value investors skip fixed stops entirely.
Do professional investors use stop losses?▼
Some do, particularly hedge funds and systematic traders. Many fundamental investors prefer thesis-based exits instead -- selling when the investment thesis breaks rather than at a predetermined price.
Related
Intrinsic Investor is for education and research only. Not financial advice.