Are Stop-Loss Orders Still Safe?
By Yolander Prinzel
If you own shares in one of the 3 stocks that rapidly lost value last week (3M, Proctor and Gamble, and Accenture), then you might be wondering whether or not a stop order (or stop-loss) is a good idea. In case you don’t know, a stop-loss is a standing order you place to sell a stock next tick once the position reaches a certain price. You would do this in order to protect yourself against a loss that you don’t want to bear.
For instance, let’s say you buy 100 shares of ABC at $100 per share. You decide that you want to sell once the stock reaches $85 because you do not wish to lose more than 15% of your investment. So you tell your broker to enter a standing stop order (or good until canceled) to sell next tick once the price hits $85.00. This allows you to tear your eyes away from the stock tickers each day and not obsessively watch over your investment because you know the system will execute your order for you.
But last week, a whole lot of stop-loss orders for MMM, PG and ACN were probably executed as these positions seemed to enter a free fall on May 6th. Since this loss was based on an error of an as yet undetermined nature, it may make some investors wonder if it isn’t a bad idea to have stop-loss orders in the system. After all—do you really want your stock sold because of an error that corrects itself within the same day?
Personally, I would not worry about it. What? After a crisis like last week’s I dare to be so calm and casual about the situation? Yes, yes I do dare. Why? Well, first of all we don’t exactly know yet what caused the error. Some people seem to think that a trader accidentally entered a B instead of an M into the trading system resulting in billions of PG shares being sold instead of millions. Now, I can’t say that I’ve touched every trading system out there, but the one that I did use did not utilize any letters to enter trades and also had safeguards when large volumes were entered. In fact, we had to give verbal confirmation for certain trade volumes—and we were not doing large institutional trades, we were simply trading accounts with values ranging from $1,000 to $10,000,000. And because some stocks (like Berkshire Hathaway) have such a large value per share, we had to give verbal confirmation for trades of certain dollar amounts—regardless of number of shares. Because of this experience, I find it hard to believe that an even more sophisticated and high-level trading system would not have similar safeguards.
Back to your stop-loss. I’m of the mind that the mistake was system-oriented and a one-off issue. Maybe buy orders were not being processed while sell orders were. Maybe the algorithmic trading systems went wrong somewhere. Either way, it is not something that you see often (after all, when was the last time this happened?) and it is probably not something that you’ll see happen again. A significant—and real—loss in your stock values based on fluctuating consumer confidence is something you could see however, and is why a stop-loss order is still a great idea.
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